Solutions Manual for CorporateF
b b b b
inance by Ross, Westerfield, and J
b b b b b
affe 10th Edition
b b
Solutions Manual b
Corporate Finance
b
Ross, Westerfield, and Jaffe10
b b b b
th
edition
b
,Solutionsb Manual
CHAPTER 1 b
INTRODUCTION TO CORPORATEFINAN b b b
CE
Answersb tob Conceptb Questions
1. Inb theb corporateb formb ofb ownership,b theb shareholdersb areb theb ownersb ofb theb firm.b Theb shareholdersb
electbthebdirectorsbofbthebcorporation,bwhobinbturnbappointbthebfirm’sbmanagement.bThisbseparationbofbow
nershipbfrombcontrolbinbthebcorporateb formbofborganizationb isbwhatbcausesbagencyb problemsbtobexist.bM
anagementbmaybactbinbitsbownborbsomeonebelse’sbbestbinterests,bratherbthanbthosebofbthebshareholders.bIfbs
uchbeventsboccur,btheybmaybcontradictbthebgoalbofbmaximizingbthebsharebpricebofbthebequitybofbthebfirm.
2. Suchborganizationsbfrequentlybpursuebsocialborbpoliticalbmissions,bsobmanybdifferentbgoalsbarebconceiva
ble.bOnebgoalbthatbisboftenbcitedbisbrevenuebminimization;bi.e.,bprovidebwhateverbgoodsbandbservicesbareb
offeredbatbtheblowestbpossiblebcostbtobsociety.bAbbetterbapproachbmightbbebtobobservebthatbevenbabnot-for-
profitbbusinessbhasbequity.bThus,bonebanswerbisbthatbtheb appropriateb goalb isb tobmaximizebthebvaluebofbt
hebequity.
3. Presumably,bthebcurrentbstockbvaluebreflectsbthebrisk,btiming,bandbmagnitudebofballbfuturebcashbflows,bbot
hbshort-termbandblong-term.bIfbthisbisbcorrect,bthenbthebstatementbisbfalse.
4. Anbargumentb canb beb madeb eitherb way.b Atb theb oneb extreme,b web couldb argueb thatb inb ab marketb economy,b
allbofbthesebthingsbarebpriced.bTherebisbthusbanboptimalblevelbof,bforbexample,bethicalband/orbillegalbbehav
ior,bandbthebframeworkbofbstockbvaluationbexplicitlybincludesbthese.bAtbthebotherbextreme,bwebcouldbargu
ebthatbthesebarebnon-
economicbphenomenabandbarebbestbhandledbthroughb theb politicalbprocess.b Ab classicb (andb highlyb relev
ant)b thoughtb questionb thatb illustratesb thisb debateb goesb somethingblikebthis:b“Abfirmbhasbestimatedbthatbt
hebcostbofbimprovingbthebsafetybofbonebofbitsbproductsbisb$30bmillion.bHowever,bthebfirmbbelievesbthatbim
provingbthebsafetybofbtheb productbwillbonlyb saveb $20bmillionbinbproductbliabilitybclaims.bWhatbshouldbt
hebfirmbdo?”
5. Thebgoalbwillbbebthebsame,bbutbthebbestbcoursebofbactionbtowardbthatbgoalbmaybbebdifferentbbecausebofbdif
feringbsocial,bpolitical,bandbeconomicbinstitutions.
6. Thebgoalbofbmanagementbshouldbbebtobmaximizebthebsharebpricebforbthebcurrentbshareholders.bIfbmanage
mentbbelievesbthatbitbcanbimprovebthebprofitabilitybofbthebfirmbsobthatbtheb shareb pricebwillbexceedb$35,bth
enbtheybshouldbfightbthebofferbfrombtheboutsidebcompany.bIfb managementbbelievesbthatbthisbbidderborboth
erbunidentifiedbbiddersbwillbactuallybpaybmorebthanb$35bperbsharebtobacquirebthebcompany,b thenb theyb sho
uldb stillb fightb theb offer.b However,b ifb theb currentb managementb cannotb increasebthebvaluebofbthebfirmbbey
ondbthebbidbprice,bandbnobotherbhigherbbidsbcomebin,bthenbmanagementbisbnotbactingb inb theb interestsb ofb t
heb shareholdersb byb fightingb theb offer.b Sinceb currentb managersb oftenb lose
, theirb jobsb whenb theb corporationb isb acquired,b poorlyb monitoredb managersb haveb anb incentiveb tob fightb
corporatebtakeoversbinbsituationsbsuchbasbthis.
7. Webwouldbexpectbagencybproblemsbtobbeblessbseverebinbotherbcountries,bprimarilybduebtobthebrelativelybs
mallbpercentagebofbindividualbownership.bFewerbindividualbownersbshouldbreducebthebnumberbofbdiverse
b opinionsb concerningb corporateb goals.b Theb highb percentageb ofb institutionalb ownershipb mightbleadbtob
abhigherbdegreebofbagreementbbetweenbownersbandbmanagersbonbdecisionsbconcerningbriskybprojects.b Inb
addition,b institutionsb mayb beb betterb ableb tob implementb effectiveb monitoringb mechanismsbonbmanagersb
thanbcanbindividualbowners,bbasedbonbthebinstitutions’bdeeperbresourcesbandbexperiencesbwithbtheirbownb
management.
8. Theb increaseb inb institutionalb ownershipb ofb stockb inb theb Unitedb Statesb andb theb growingb activismb ofbt
heseb largeb shareholderb groupsb mayb leadb tob ab reductionb inb agencyb problemsb forb U.S.b corporationsb andba
bmorebefficientbmarketbforbcorporatebcontrol.bHowever,bthisbmaybnotbalwaysbbebthebcase.bIfbthebmanagers
bofbthebmutualbfundborbpensionbplanbarebnotbconcernedbwithbthebinterestsbofbthebinvestors,bthebagencybpro
blembcouldbpotentiallybremainbthebsame,borbevenbincreasebsincebtherebisbthebpossibilitybofbagencybproble
msbbetweenbthebfundbandbitsbinvestors.
9. Howbmuchbisbtoobmuch?bWhobisbworthbmore,bLarrybEllsionborbTigerbWoods?bThebsimplestbanswerbisbtha
tbtherebisbabmarketbforbexecutivesbjustb asbtherebisb forballbtypesbofblabor.bExecutivebcompensationbisbthebp
ricebthatbclearsbthebmarket.bThebsamebisbtruebforbathletesbandbperformers.bHavingbsaidbthat,bonebaspectbofb
executivebcompensationbdeservesbcomment.bAbprimarybreasonbexecutivebcompensationbhasbgrownbsobdr
amaticallybisbthatbcompaniesbhavebincreasinglyb movedb tob stock-
basedb compensation.bSuchbmovementbisbobviouslybconsistentbwithbthebattemptbtobbetterbalignbstockhold
erbandbmanagementbinterests.bInbrecentbyears,bstockbpricesbhavebsoared,bsobmanagementbhasbcleanedbup.b
Itbisbsometimesbarguedbthatbmuchbofbthisbrewardbisbsimplybduebtobrisingbstockbpricesbinbgeneral,bnotbmana
gerialbperformance.bPerhapsbinbthebfuture,bexecutivebcompensationbwillbbebdesignedbtobrewardb onlybdiff
erentialbperformance,bi.e.,bstockbpricebincreasesbinbexcessbofbgeneralbmarketbincreases.
10. Maximizingbthebcurrentbsharebpricebisbthebsamebasbmaximizingbthebfuturebsharebpricebatbanybfuturebperio
d.b Theb valueb ofb ab shareb ofb stockb dependsb onb allb ofb theb futureb cashb flowsb ofb company.b Anotherbwaybt
oblookbatbthisbisbthat,bbarringblargebcashbpaymentsbtobshareholders,b theb expectedb pricebofb thebstockbmus
tbbebhigherbinbthebfuturebthanbitbisbtoday.bWhobwouldbbuybabstockbforb$100btodaybwhenbthebsharebpricebinb
onebyearbisbexpectedbtobbeb$80?
, Solutionsb Manual
CHAPTER 2 b
FINANCIAL STATEMENTS AND CASHFL b b b b
OW
Answersb tobConceptsb Reviewb andb Criticalb Thinkingb Questions
1. True.bEverybassetbcanbbebconvertedbtobcashbatbsomebprice.bHowever,bwhenbwebarebreferringbtobabliquidbas
set,bthebaddedbassumptionbthatbthebassetbcanbbebquicklybconvertedbtobcashbatborbnearbmarketbvaluebisbimp
ortant.
2. Thebrecognitionbandbmatchingbprinciplesbinbfinancialbaccountingbcallbforbrevenues,bandbthebcostsbassocia
tedbwithbproducingbthosebrevenues,btobbeb“booked”bwhenbthebrevenuebprocessbisbessentiallybcomplete,bn
otbnecessarilybwhenbthebcashbisbcollectedborbbillsbarebpaid.bNotebthatbthisbwaybisbnotbnecessarilybcorrect;bi
t’sbthebwaybaccountantsbhavebchosenbtobdobit.
3. Theb bottomb lineb numberb showsb theb changeb inb theb cashb balanceb onb theb balanceb sheet.b Asb such,b itb isb notb
abusefulbnumberbforbanalyzingbabcompany.
4. Thebmajorbdifferencebisbthebtreatmentbofbinterestbexpense.bThebaccountingb statementbofbcashb flowsbtreat
sbinterestbasbanboperatingbcashbflow,bwhilebtheb financialbcashbflowsbtreatbinterestbasbab financingbcashbflo
w.bTheblogicbofbthebaccountingbstatementbofbcashbflowsbisbthatbsincebinterestbappearsbonbthebincomebstate
ment,bwhichbshowsbtheboperationsbforbthebperiod,bitbisbanboperatingbcashbflow.bInbreality,binterestbisbabfina
ncingbexpense,bwhichbresultsbfrombthebcompany’sbchoicebofbdebtbandbequity.bWebwillbhavebmorebtobsayba
boutbthisbinbablaterbchapter.bWhenbcomparingbthebtwobcashbflowbstatements,bthebfinancialbstatementbofbca
shbflowsbisbabmorebappropriatebmeasurebofbtheb company’sb performancebbecausebofbitsbtreatmentbofbinter
est.
5. Marketb valuesb canb neverb beb negative.b Imagineb ab shareb ofb stockb sellingb forb –
$20.b Thisb wouldb meanbthatb ifb youb placedb anb orderb forb 100b shares,b youb wouldb getb theb stockb alongb wi
thb ab checkb forb $2,000.bHowbmanybsharesbdobyoubwantbtobbuy?bMorebgenerally,bbecausebofbcorporateban
db individualbbankruptcyblaws,bnetbworthbforbabpersonborbabcorporationbcannotbbebnegative,bimplyingbthat
bliabilitiesbcannotbexceedbassetsbinbmarketbvalue.
6. Forbabsuccessfulbcompanybthatbisbrapidlybexpanding,bforbexample,bcapitalboutlaysbwillb beb large,bpossibl
ybleadingbtobnegativebcashbflowbfrombassets.bInbgeneral,bwhatbmattersbisbwhetherbthebmoneybisbspentbwis
ely,bnotbwhetherbcashbflowbfrombassetsbisbpositiveborbnegative.
7. It’sbprobablybnotbabgoodbsignbforbanbestablishedbcompanybtobhavebnegativebcashbflowbfromboperations,bbu
tbitbwouldbbebfairlybordinarybforbabstart-up,bsobitbdepends.
b b b b
inance by Ross, Westerfield, and J
b b b b b
affe 10th Edition
b b
Solutions Manual b
Corporate Finance
b
Ross, Westerfield, and Jaffe10
b b b b
th
edition
b
,Solutionsb Manual
CHAPTER 1 b
INTRODUCTION TO CORPORATEFINAN b b b
CE
Answersb tob Conceptb Questions
1. Inb theb corporateb formb ofb ownership,b theb shareholdersb areb theb ownersb ofb theb firm.b Theb shareholdersb
electbthebdirectorsbofbthebcorporation,bwhobinbturnbappointbthebfirm’sbmanagement.bThisbseparationbofbow
nershipbfrombcontrolbinbthebcorporateb formbofborganizationb isbwhatbcausesbagencyb problemsbtobexist.bM
anagementbmaybactbinbitsbownborbsomeonebelse’sbbestbinterests,bratherbthanbthosebofbthebshareholders.bIfbs
uchbeventsboccur,btheybmaybcontradictbthebgoalbofbmaximizingbthebsharebpricebofbthebequitybofbthebfirm.
2. Suchborganizationsbfrequentlybpursuebsocialborbpoliticalbmissions,bsobmanybdifferentbgoalsbarebconceiva
ble.bOnebgoalbthatbisboftenbcitedbisbrevenuebminimization;bi.e.,bprovidebwhateverbgoodsbandbservicesbareb
offeredbatbtheblowestbpossiblebcostbtobsociety.bAbbetterbapproachbmightbbebtobobservebthatbevenbabnot-for-
profitbbusinessbhasbequity.bThus,bonebanswerbisbthatbtheb appropriateb goalb isb tobmaximizebthebvaluebofbt
hebequity.
3. Presumably,bthebcurrentbstockbvaluebreflectsbthebrisk,btiming,bandbmagnitudebofballbfuturebcashbflows,bbot
hbshort-termbandblong-term.bIfbthisbisbcorrect,bthenbthebstatementbisbfalse.
4. Anbargumentb canb beb madeb eitherb way.b Atb theb oneb extreme,b web couldb argueb thatb inb ab marketb economy,b
allbofbthesebthingsbarebpriced.bTherebisbthusbanboptimalblevelbof,bforbexample,bethicalband/orbillegalbbehav
ior,bandbthebframeworkbofbstockbvaluationbexplicitlybincludesbthese.bAtbthebotherbextreme,bwebcouldbargu
ebthatbthesebarebnon-
economicbphenomenabandbarebbestbhandledbthroughb theb politicalbprocess.b Ab classicb (andb highlyb relev
ant)b thoughtb questionb thatb illustratesb thisb debateb goesb somethingblikebthis:b“Abfirmbhasbestimatedbthatbt
hebcostbofbimprovingbthebsafetybofbonebofbitsbproductsbisb$30bmillion.bHowever,bthebfirmbbelievesbthatbim
provingbthebsafetybofbtheb productbwillbonlyb saveb $20bmillionbinbproductbliabilitybclaims.bWhatbshouldbt
hebfirmbdo?”
5. Thebgoalbwillbbebthebsame,bbutbthebbestbcoursebofbactionbtowardbthatbgoalbmaybbebdifferentbbecausebofbdif
feringbsocial,bpolitical,bandbeconomicbinstitutions.
6. Thebgoalbofbmanagementbshouldbbebtobmaximizebthebsharebpricebforbthebcurrentbshareholders.bIfbmanage
mentbbelievesbthatbitbcanbimprovebthebprofitabilitybofbthebfirmbsobthatbtheb shareb pricebwillbexceedb$35,bth
enbtheybshouldbfightbthebofferbfrombtheboutsidebcompany.bIfb managementbbelievesbthatbthisbbidderborboth
erbunidentifiedbbiddersbwillbactuallybpaybmorebthanb$35bperbsharebtobacquirebthebcompany,b thenb theyb sho
uldb stillb fightb theb offer.b However,b ifb theb currentb managementb cannotb increasebthebvaluebofbthebfirmbbey
ondbthebbidbprice,bandbnobotherbhigherbbidsbcomebin,bthenbmanagementbisbnotbactingb inb theb interestsb ofb t
heb shareholdersb byb fightingb theb offer.b Sinceb currentb managersb oftenb lose
, theirb jobsb whenb theb corporationb isb acquired,b poorlyb monitoredb managersb haveb anb incentiveb tob fightb
corporatebtakeoversbinbsituationsbsuchbasbthis.
7. Webwouldbexpectbagencybproblemsbtobbeblessbseverebinbotherbcountries,bprimarilybduebtobthebrelativelybs
mallbpercentagebofbindividualbownership.bFewerbindividualbownersbshouldbreducebthebnumberbofbdiverse
b opinionsb concerningb corporateb goals.b Theb highb percentageb ofb institutionalb ownershipb mightbleadbtob
abhigherbdegreebofbagreementbbetweenbownersbandbmanagersbonbdecisionsbconcerningbriskybprojects.b Inb
addition,b institutionsb mayb beb betterb ableb tob implementb effectiveb monitoringb mechanismsbonbmanagersb
thanbcanbindividualbowners,bbasedbonbthebinstitutions’bdeeperbresourcesbandbexperiencesbwithbtheirbownb
management.
8. Theb increaseb inb institutionalb ownershipb ofb stockb inb theb Unitedb Statesb andb theb growingb activismb ofbt
heseb largeb shareholderb groupsb mayb leadb tob ab reductionb inb agencyb problemsb forb U.S.b corporationsb andba
bmorebefficientbmarketbforbcorporatebcontrol.bHowever,bthisbmaybnotbalwaysbbebthebcase.bIfbthebmanagers
bofbthebmutualbfundborbpensionbplanbarebnotbconcernedbwithbthebinterestsbofbthebinvestors,bthebagencybpro
blembcouldbpotentiallybremainbthebsame,borbevenbincreasebsincebtherebisbthebpossibilitybofbagencybproble
msbbetweenbthebfundbandbitsbinvestors.
9. Howbmuchbisbtoobmuch?bWhobisbworthbmore,bLarrybEllsionborbTigerbWoods?bThebsimplestbanswerbisbtha
tbtherebisbabmarketbforbexecutivesbjustb asbtherebisb forballbtypesbofblabor.bExecutivebcompensationbisbthebp
ricebthatbclearsbthebmarket.bThebsamebisbtruebforbathletesbandbperformers.bHavingbsaidbthat,bonebaspectbofb
executivebcompensationbdeservesbcomment.bAbprimarybreasonbexecutivebcompensationbhasbgrownbsobdr
amaticallybisbthatbcompaniesbhavebincreasinglyb movedb tob stock-
basedb compensation.bSuchbmovementbisbobviouslybconsistentbwithbthebattemptbtobbetterbalignbstockhold
erbandbmanagementbinterests.bInbrecentbyears,bstockbpricesbhavebsoared,bsobmanagementbhasbcleanedbup.b
Itbisbsometimesbarguedbthatbmuchbofbthisbrewardbisbsimplybduebtobrisingbstockbpricesbinbgeneral,bnotbmana
gerialbperformance.bPerhapsbinbthebfuture,bexecutivebcompensationbwillbbebdesignedbtobrewardb onlybdiff
erentialbperformance,bi.e.,bstockbpricebincreasesbinbexcessbofbgeneralbmarketbincreases.
10. Maximizingbthebcurrentbsharebpricebisbthebsamebasbmaximizingbthebfuturebsharebpricebatbanybfuturebperio
d.b Theb valueb ofb ab shareb ofb stockb dependsb onb allb ofb theb futureb cashb flowsb ofb company.b Anotherbwaybt
oblookbatbthisbisbthat,bbarringblargebcashbpaymentsbtobshareholders,b theb expectedb pricebofb thebstockbmus
tbbebhigherbinbthebfuturebthanbitbisbtoday.bWhobwouldbbuybabstockbforb$100btodaybwhenbthebsharebpricebinb
onebyearbisbexpectedbtobbeb$80?
, Solutionsb Manual
CHAPTER 2 b
FINANCIAL STATEMENTS AND CASHFL b b b b
OW
Answersb tobConceptsb Reviewb andb Criticalb Thinkingb Questions
1. True.bEverybassetbcanbbebconvertedbtobcashbatbsomebprice.bHowever,bwhenbwebarebreferringbtobabliquidbas
set,bthebaddedbassumptionbthatbthebassetbcanbbebquicklybconvertedbtobcashbatborbnearbmarketbvaluebisbimp
ortant.
2. Thebrecognitionbandbmatchingbprinciplesbinbfinancialbaccountingbcallbforbrevenues,bandbthebcostsbassocia
tedbwithbproducingbthosebrevenues,btobbeb“booked”bwhenbthebrevenuebprocessbisbessentiallybcomplete,bn
otbnecessarilybwhenbthebcashbisbcollectedborbbillsbarebpaid.bNotebthatbthisbwaybisbnotbnecessarilybcorrect;bi
t’sbthebwaybaccountantsbhavebchosenbtobdobit.
3. Theb bottomb lineb numberb showsb theb changeb inb theb cashb balanceb onb theb balanceb sheet.b Asb such,b itb isb notb
abusefulbnumberbforbanalyzingbabcompany.
4. Thebmajorbdifferencebisbthebtreatmentbofbinterestbexpense.bThebaccountingb statementbofbcashb flowsbtreat
sbinterestbasbanboperatingbcashbflow,bwhilebtheb financialbcashbflowsbtreatbinterestbasbab financingbcashbflo
w.bTheblogicbofbthebaccountingbstatementbofbcashbflowsbisbthatbsincebinterestbappearsbonbthebincomebstate
ment,bwhichbshowsbtheboperationsbforbthebperiod,bitbisbanboperatingbcashbflow.bInbreality,binterestbisbabfina
ncingbexpense,bwhichbresultsbfrombthebcompany’sbchoicebofbdebtbandbequity.bWebwillbhavebmorebtobsayba
boutbthisbinbablaterbchapter.bWhenbcomparingbthebtwobcashbflowbstatements,bthebfinancialbstatementbofbca
shbflowsbisbabmorebappropriatebmeasurebofbtheb company’sb performancebbecausebofbitsbtreatmentbofbinter
est.
5. Marketb valuesb canb neverb beb negative.b Imagineb ab shareb ofb stockb sellingb forb –
$20.b Thisb wouldb meanbthatb ifb youb placedb anb orderb forb 100b shares,b youb wouldb getb theb stockb alongb wi
thb ab checkb forb $2,000.bHowbmanybsharesbdobyoubwantbtobbuy?bMorebgenerally,bbecausebofbcorporateban
db individualbbankruptcyblaws,bnetbworthbforbabpersonborbabcorporationbcannotbbebnegative,bimplyingbthat
bliabilitiesbcannotbexceedbassetsbinbmarketbvalue.
6. Forbabsuccessfulbcompanybthatbisbrapidlybexpanding,bforbexample,bcapitalboutlaysbwillb beb large,bpossibl
ybleadingbtobnegativebcashbflowbfrombassets.bInbgeneral,bwhatbmattersbisbwhetherbthebmoneybisbspentbwis
ely,bnotbwhetherbcashbflowbfrombassetsbisbpositiveborbnegative.
7. It’sbprobablybnotbabgoodbsignbforbanbestablishedbcompanybtobhavebnegativebcashbflowbfromboperations,bbu
tbitbwouldbbebfairlybordinarybforbabstart-up,bsobitbdepends.
