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