SOLUTION MANUAL FOR Principles Of Corporate
Finance 14th Edition By Richard Brealey, Stewart
Myers, ALL Chapters (1 - 34)
, TABLE OF CONTENTS
Chapter 1: Introduction to Corporate Finance
Chapter 2: How to Calculate Present Values
Chapter 3: Valuing Bonds
Chapter 4: Valuing Stocks
Chapter 5: Net Present Value and Other Investment Criteria
Chapter 6: Making Investment Decisions with the Net Present Value Rule
Chapter 7: Introduction to Risk, Diversification, and Portfolio Selection
Chapter 8: The Capital Asset Pricing Model
Chapter 9: Risk and the Cost of Capital
Chapter 10: Project Analysis
Chapter 11: How to Ensure That Projects Truly Have PositiveNPVs
Chapter 12: Efficient Markets and Behavioral Finance
Chapter 13: An Overview of Corporate Financing
Chapter 14: How Corporations Issue Securities
Chapter 15: Payout Policy
Chapter 16: Does Debt Policy Matter?
Chapter 17: How Much Should a Corporation Borrow?
Chapter 18: Financing and Valuation
Chapter 19: Agency Problems and Corporate Governance
Chapter 20: Stakeholder Capitalism and Responsible Business
Chapter 21: Understanding Options
Chapter 22: Valuing Options
Chapter 23: Real Options
,Chapter 24: Credit Risk and the Value of Corporate Debt
Chapter 25: The Many Different Kinds of Debt
Chapter 26: Leasing
Chapter 27: Managing Risk
Chapter 28: International Financial Management
Chapter 29: Financial Analysis
Chapter 30: Financial Planning
Chapter 31: Working Capital Management
Chapter 32: Mergers
Chapter 33: Corporate Restructuring
Chapter 34: Conclusion: What We Do and Do Not Know about Finance
CHAPTER 1
Introduction to Corporate Finance
The values shown in the solutions may be rounded for display purposes. However, the answers werederived using a spreadsheet without any
intermediate rounding.
Answers to Problem Sets
1. a. real
b. executive airplanes
c. brand names
d. financial
e. bonds
*f. investment or capital expenditure
*g. capital budgeting or investment
h. 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, these 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. Corporations sell
financial assets to raise the cash to invest in real assets such as plant and equipment. Some real
assets are intangible.
b. Capital expenditure means investment in real assets. Financing means raising the cashfor this
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 hasunlimited
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 betransferred
without affecting operations, and managers can be fired with no effect on ownership. Other forms 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 forinvestors,
transferability of ownership, a separate legal personality of the corporation, and delegated centralized
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,enter, 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 separation of
ownership from management typically leads to agency problems, where managers prefer to consume private
perks or make other decisions for their private benefit—rather than maximize shareholder wealth.
Shareholders tend to exercise less oversight of each individual investment as their diversification increases.
Finally, the corporation‘s separate legal personalitymakes 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 hopefully balance their 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 capitalwould 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 more likely
to act in their own interests rather than in shareholders‘. If a firm instituted anew takeover defense, we might
expect to see the value of its shares decline as agency problems increase and less shareholder value
maximization occurs. The counterargument is thatdefensive measures allow managers to 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 investment 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,.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 year
($200,000 × 1.08, forgoing all consumption this year). He should invest all of his wealthto earn $216,000 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
203,704
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 all this
year, he can now have a total of $203,703.70 ($200,000 × 1.10/1.08) this yearor $220,000 next 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 amount 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 using 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 individualproject 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 cash
flows.
c. True. The opportunity cost of capital is dependent on the rates of returns shareholders canearn 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.Therefore,
in the Tenth year, you will earn $1,423.31 × 0.04 = $56.93
Est time: 01-05
3.
Transistors Transistors r)t
2019 1972
32, 000, 000, 000 2, 250 r)48
r 40.94% 59.00% rPredicted
Est time: 01-05
4. The ―Rule of 72‖ is a rule of thumb that says with discrete compounding the time it takes for an investment
to double in value is roughly 72/interest rate (in percent).
Therefore, without a calculator, the Rule of 72 estimate is:Time to
double = 72 / r
Time to double =
Time to double = 18 years, so less than 25 years.
, If you did have a calculator handy, this estimate is verified as followed:
Ct = PV × (1 + r)t
t = ln2 / ln1.04
t = 17.67 years
Est time: 01-05
5. a. Using the inflation adjusted 1958 price of $1,060, the real return per annum is:
$450,300,000 = $1,060 × (1 + r)(2017-1958)
r = [$450,300,000/$1,060](1/59 ) – 1 = 0.2456 or 24.56% per annum
b. Using the inflation adjusted 1519 price of $575,000, the real return per annum is:
$450,300,000 = $575,000 × (1 + r)(2017-1519)
r = [$450,300,000/$575,000](1/498 ) – 1 = 0.0135 or 1.35% per annum
Est time: 01-05
6. Ct = PV × (1 + r)t
C8 = $100 × 1.158
C8 = $305.90
Est time: 01-05
7. a. Ct = PV × (1 + r)t
C10 = $100 × 1.0610
C10 = $179.08
b. Ct = PV × (1 + r)t C20
= $100 × 1.0620C20 =
$320.71
c. Ct = PV × (1 + r)t C10
= $100 × 1.0410C10 =
$148.02
d. Ct = PV × (1 + r)t C20
= $100 × 1.0420C20 =
$219.11
Est time: 01-05
8. a. PV = Ct × DFt
DFt = $125 / $139
DFt = .8993
, b. Ct = PV × (1 + r)t
$139 = $125 × (1+r)5
r = [$139/$125](1/5) – 1 = 0.0215 or 2.15%
Est time: 01-05
9. PV = Ct / (1 + r)t
PV = $.099
PV = $172.20
Est time: 01-05
10. PV = C1 / (1 + r)1 + C2 / (1 + r)2 + C3 / (1 + r)3 PV
= $.15 + $.152 + $.153PV =
$1,003.28
NPV = PV – investment
NPV = $1,003.28 – 1,200
NPV = –$196.72
Est time: 01-05
11. The basic present value formula is: PV = C / (1 + r)t
a. PV = $.0110
PV = $90.53
b. PV = $.1310
PV = $29.46
c. PV = $.2515
PV = $3.52
d. PV = C1 / (1 + r) + C2 / (1 + r)2 + C3 / (1 + r)3 PV
= $.12 + $.122 + $.123PV =
$89.29 + $79.72 + $71.18
PV = $240.18
Est time: 01-05
10
(1.12)
Ct
12.
t
t 0
NPV = –$380,000 + $50,.12 + $57,.122 + $75,.123 + $80,.124 +
$85,.125 + $92,.126 + $92,.127 + $80,.128 + $68,.129
+ $50,.1210
NPV = $23,696.15
Est time: 01-05
, 13. a. NPV = – Investment + C × ((1 / r) – {1 / [r(1 + r)t]})
NPV = –$800,000 + $170,000 × ((1 / .14) – {1 / [.14(1.14)10]})
NPV = $86,739.66
b. After five years, the factory‘s value will be the present value of the remaining cash flows:PV =
$170,000 × ((1 / .14) – {1 / [.14(1.14)(10 – 5)]})
PV = $583,623.76
Est time: 01-05
14. Use the formula: NPV = –C0 + C1 / (1 + r) + C2 / (1 + r)2
NPV5% = –$700,000 + $30,.05 + $870,.052
NPV5% = $117,687.07
NPV10% = –$700,000 + $30,.10 + $870,.102
NPV10% = $46,280.99
NPV15% = –$700,000 + $30,.15 + $870,.152
NPV15% = –$16,068.05
The figure below shows that the project has a zero NPV at about 13.65%.
NPV13.65% = –$700,000 + $30,.1365 + $870,.13652
NPV13.65% = –$36.83
Est time: 11-15
Finance 14th Edition By Richard Brealey, Stewart
Myers, ALL Chapters (1 - 34)
, TABLE OF CONTENTS
Chapter 1: Introduction to Corporate Finance
Chapter 2: How to Calculate Present Values
Chapter 3: Valuing Bonds
Chapter 4: Valuing Stocks
Chapter 5: Net Present Value and Other Investment Criteria
Chapter 6: Making Investment Decisions with the Net Present Value Rule
Chapter 7: Introduction to Risk, Diversification, and Portfolio Selection
Chapter 8: The Capital Asset Pricing Model
Chapter 9: Risk and the Cost of Capital
Chapter 10: Project Analysis
Chapter 11: How to Ensure That Projects Truly Have PositiveNPVs
Chapter 12: Efficient Markets and Behavioral Finance
Chapter 13: An Overview of Corporate Financing
Chapter 14: How Corporations Issue Securities
Chapter 15: Payout Policy
Chapter 16: Does Debt Policy Matter?
Chapter 17: How Much Should a Corporation Borrow?
Chapter 18: Financing and Valuation
Chapter 19: Agency Problems and Corporate Governance
Chapter 20: Stakeholder Capitalism and Responsible Business
Chapter 21: Understanding Options
Chapter 22: Valuing Options
Chapter 23: Real Options
,Chapter 24: Credit Risk and the Value of Corporate Debt
Chapter 25: The Many Different Kinds of Debt
Chapter 26: Leasing
Chapter 27: Managing Risk
Chapter 28: International Financial Management
Chapter 29: Financial Analysis
Chapter 30: Financial Planning
Chapter 31: Working Capital Management
Chapter 32: Mergers
Chapter 33: Corporate Restructuring
Chapter 34: Conclusion: What We Do and Do Not Know about Finance
CHAPTER 1
Introduction to Corporate Finance
The values shown in the solutions may be rounded for display purposes. However, the answers werederived using a spreadsheet without any
intermediate rounding.
Answers to Problem Sets
1. a. real
b. executive airplanes
c. brand names
d. financial
e. bonds
*f. investment or capital expenditure
*g. capital budgeting or investment
h. 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, these 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. Corporations sell
financial assets to raise the cash to invest in real assets such as plant and equipment. Some real
assets are intangible.
b. Capital expenditure means investment in real assets. Financing means raising the cashfor this
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 hasunlimited
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 betransferred
without affecting operations, and managers can be fired with no effect on ownership. Other forms 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 forinvestors,
transferability of ownership, a separate legal personality of the corporation, and delegated centralized
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,enter, 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 separation of
ownership from management typically leads to agency problems, where managers prefer to consume private
perks or make other decisions for their private benefit—rather than maximize shareholder wealth.
Shareholders tend to exercise less oversight of each individual investment as their diversification increases.
Finally, the corporation‘s separate legal personalitymakes 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 hopefully balance their 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 capitalwould 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 more likely
to act in their own interests rather than in shareholders‘. If a firm instituted anew takeover defense, we might
expect to see the value of its shares decline as agency problems increase and less shareholder value
maximization occurs. The counterargument is thatdefensive measures allow managers to 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 investment 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,.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 year
($200,000 × 1.08, forgoing all consumption this year). He should invest all of his wealthto earn $216,000 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
203,704
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 all this
year, he can now have a total of $203,703.70 ($200,000 × 1.10/1.08) this yearor $220,000 next 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 amount 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 using 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 individualproject 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 cash
flows.
c. True. The opportunity cost of capital is dependent on the rates of returns shareholders canearn 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.Therefore,
in the Tenth year, you will earn $1,423.31 × 0.04 = $56.93
Est time: 01-05
3.
Transistors Transistors r)t
2019 1972
32, 000, 000, 000 2, 250 r)48
r 40.94% 59.00% rPredicted
Est time: 01-05
4. The ―Rule of 72‖ is a rule of thumb that says with discrete compounding the time it takes for an investment
to double in value is roughly 72/interest rate (in percent).
Therefore, without a calculator, the Rule of 72 estimate is:Time to
double = 72 / r
Time to double =
Time to double = 18 years, so less than 25 years.
, If you did have a calculator handy, this estimate is verified as followed:
Ct = PV × (1 + r)t
t = ln2 / ln1.04
t = 17.67 years
Est time: 01-05
5. a. Using the inflation adjusted 1958 price of $1,060, the real return per annum is:
$450,300,000 = $1,060 × (1 + r)(2017-1958)
r = [$450,300,000/$1,060](1/59 ) – 1 = 0.2456 or 24.56% per annum
b. Using the inflation adjusted 1519 price of $575,000, the real return per annum is:
$450,300,000 = $575,000 × (1 + r)(2017-1519)
r = [$450,300,000/$575,000](1/498 ) – 1 = 0.0135 or 1.35% per annum
Est time: 01-05
6. Ct = PV × (1 + r)t
C8 = $100 × 1.158
C8 = $305.90
Est time: 01-05
7. a. Ct = PV × (1 + r)t
C10 = $100 × 1.0610
C10 = $179.08
b. Ct = PV × (1 + r)t C20
= $100 × 1.0620C20 =
$320.71
c. Ct = PV × (1 + r)t C10
= $100 × 1.0410C10 =
$148.02
d. Ct = PV × (1 + r)t C20
= $100 × 1.0420C20 =
$219.11
Est time: 01-05
8. a. PV = Ct × DFt
DFt = $125 / $139
DFt = .8993
, b. Ct = PV × (1 + r)t
$139 = $125 × (1+r)5
r = [$139/$125](1/5) – 1 = 0.0215 or 2.15%
Est time: 01-05
9. PV = Ct / (1 + r)t
PV = $.099
PV = $172.20
Est time: 01-05
10. PV = C1 / (1 + r)1 + C2 / (1 + r)2 + C3 / (1 + r)3 PV
= $.15 + $.152 + $.153PV =
$1,003.28
NPV = PV – investment
NPV = $1,003.28 – 1,200
NPV = –$196.72
Est time: 01-05
11. The basic present value formula is: PV = C / (1 + r)t
a. PV = $.0110
PV = $90.53
b. PV = $.1310
PV = $29.46
c. PV = $.2515
PV = $3.52
d. PV = C1 / (1 + r) + C2 / (1 + r)2 + C3 / (1 + r)3 PV
= $.12 + $.122 + $.123PV =
$89.29 + $79.72 + $71.18
PV = $240.18
Est time: 01-05
10
(1.12)
Ct
12.
t
t 0
NPV = –$380,000 + $50,.12 + $57,.122 + $75,.123 + $80,.124 +
$85,.125 + $92,.126 + $92,.127 + $80,.128 + $68,.129
+ $50,.1210
NPV = $23,696.15
Est time: 01-05
, 13. a. NPV = – Investment + C × ((1 / r) – {1 / [r(1 + r)t]})
NPV = –$800,000 + $170,000 × ((1 / .14) – {1 / [.14(1.14)10]})
NPV = $86,739.66
b. After five years, the factory‘s value will be the present value of the remaining cash flows:PV =
$170,000 × ((1 / .14) – {1 / [.14(1.14)(10 – 5)]})
PV = $583,623.76
Est time: 01-05
14. Use the formula: NPV = –C0 + C1 / (1 + r) + C2 / (1 + r)2
NPV5% = –$700,000 + $30,.05 + $870,.052
NPV5% = $117,687.07
NPV10% = –$700,000 + $30,.10 + $870,.102
NPV10% = $46,280.99
NPV15% = –$700,000 + $30,.15 + $870,.152
NPV15% = –$16,068.05
The figure below shows that the project has a zero NPV at about 13.65%.
NPV13.65% = –$700,000 + $30,.1365 + $870,.13652
NPV13.65% = –$36.83
Est time: 11-15
