CHAPTERu1
IntroductionutouCorporateuFinance
Theuvaluesushownuinutheusolutionsumayubeuroundeduforudisplayupurposes.uHowever,utheuanswersuwereuderi
veduusinguauspreadsheetuwithoutuanyuintermediateurounding.
AnswersutouProblemuSets
1. a. real
b. executiveuairplanes
c. brandunames
d. financial
e. bonds
*f. investmentuorucapitaluexpenditure
*g. capitalubudgetinguoruinvestment
h. financing
*Noteuthatufuanduguareuinterchangeableuinutheuquestion.
Estutime:u01-05
2. Autrademark,uaufactory,uundevelopeduland,uanduyouruworkuforceu(c,ud,ue,uandug)uareuallurealuassets.u
Realuassetsuareuidentifiableuasuitemsuwithuintrinsicuvalue.uTheuothersuinutheulistuareufinancialuassets,u
thatuis,utheseuassetsuderiveuvalueubecauseuofuaucontractualuclaim.
Estutime:u01-05
3. a.
Financialuassets,usuchuasustocksuorubankuloans,uareuclaimsuheldubyuinvestors.uCor
porationsusellufinancialuassetsutouraiseutheucashutouinvestuinurealuassetsusuchuasuplantuand
uequipment.uSomeurealuassetsuareuintangible.
b. Capitaluexpenditureumeansuinvestmentuinurealuassets.uFinancingumeansuraisingutheucashu
foruthisuinvestment.
c. Theusharesuofupublicucorporationsuareutradeduonustockuexchangesuanducanubeupurchasedu
byuauwideurangeuofuinvestors.uTheusharesuofucloselyuhelducorporationsuareunotupubliclyutra
deduanduareuheldubyuausmallugroupuofuprivateuinvestors.
d. Unlimiteduliability:uInvestorsuareuresponsibleuforuallutheufirm‘sudebts.uAusoleuproprietoruhas
unlimiteduliability.uInvestorsuinucorporationsuhaveulimiteduliability.uTheyucanuloseutheiruinv
u
estment,ubutunoumore.
Estutime:u01-05
©uMcGrawuHilluLLC.uAllurightsureserved.uNoureproductionuorudistributionuwithoututheuprioruwrittenuconsentuofuMcGrawuHilluLL
C.
,4. Itemsucuanduduapplyutoucorporations.uBecauseucorporationsuhaveuperpetualulife,uownershipucanubeu
transferreduwithoutuaffectinguoperations,uandumanagersucanubeufireduwithunoueffectuonuownership.u
Otheruformsuofubusinessumayuhaveuunlimiteduliabilityuandulimitedulife.
Estutime:u01-05
5. Separationuofuownershipufacilitatesutheukeyuattributesuofuaucorporation,uincludingulimiteduliabilityuforu
investors,utransferabilityuofuownership,uauseparateulegalupersonalityuofutheucorporation,uandudelega
teducentralizedumanagement.uTheseufouruattributesuprovideusubstantialubenefituforuinvestors,uinclu
dingutheuabilityutoudiversifyutheiruinvestmentuamongumanyuuncorrelatedureturns—
auveryuvaluableutooluexploreduinulateruchapters.uAlso,utheseuattributesuallowuinvestorsutouquicklyuexi
t,uenter,uorushortuselluanuinvestment,utherebyugeneratinguanuactiveuliquidumarketuforucorporations.
However,utheseupositiveuaspectsualsouintroduceusubstantialunegativeuexternalitiesuasuwell.uTheuse
parationuofuownershipufromumanagementutypicallyuleadsutouagencyuproblems,uwhereumanagersupr
eferutouconsumeuprivateuperksuorumakeuotherudecisionsuforutheiruprivateubenefit—
ratheruthanumaximizeushareholderuwealth.uShareholdersutendutouexerciseulessuoversightuofueachui
ndividualuinvestmentuasutheirudiversificationuincreases.uFinally,utheucorporation‘suseparateulegalup
ersonalityumakesuitudifficultutouenforceuaccountabilityuifutheyuexternalizeucostsuontousociety.
Estutime:u01-05
6. Shareholdersuwilluonlyuvoteutoumaximizeushareholderuwealth.uShareholdersucanumodifyutheirup
atternuofuconsumptionuthroughuborrowinguandulending,umatchuriskupreferences,uanduhopefullyub
alanceutheiruownucheckbooksu(oruhireuauqualifieduprofessionalutouhelputhemuwithutheseutasks).
Estutime:u01-05
7. Ifutheuinvestmentuincreasesutheufirm‘suwealth,uituincreasesutheufirm‘sushareuvalue.u Ms.uEspinozau
coulduthenusellusomeuoruallutheseumoreuvaluableusharesutouprovideuforuheruretirementuincome.
Estutime:u01-05
8. a.
Assuminguthatutheuencabulatorumarketuisurisky,uanu8%uexpecteduret
urnuonutheuF&Huencabulatoruinvestmentsumayubeuinferiorutouau4%ureturnuo
nuU.S.
governmentusecurities,udependinguonutheurelativeuriskubetweenutheutwouassets.
b.
UnlessutheufinancialuassetsuareuasusafeuasuU.S.ugovernmentusecurities,utheirucostuofu
capitaluwouldubeuhigher.uTheuCFOucoulduconsideruexpectedureturnsuonuassetsuwithusimilarur
isk.
Estutime:u06-10
9. Managersuwoulduactuinushareholders‘uinterestsubecauseutheyuhaveuaulegaludutyutouactuinutheiruintere
sts.uManagersumayualsoureceiveucompensation—
ubonuses,ustock,uanduoptionupayoutsuwithuvalueutiedu(roughly)utoufirm uperformance.uManagersumayu
fearupersonalureputationaludamageufromunotuactinguinushareholders‘uinterests.uAndumanagersucanu
beufiredubyutheuboarduofudirectorsu(electedubyushareholders).u Ifumanagersustillufailutouactuinusharehol
ders‘uinterests,ushareholdersumayusellutheirushares,uloweringutheustockupriceuandupotentiallyucreatin
gutheupossibilityuofuautakeover,uwhichucanuagainuleadutouchangesuinutheuboarduofudirectorsuanduseni
©uMcGrawuHilluLLC.uAllurightsureserved.uNoureproductionuorudistributionuwithoututheuprioruwrittenuconsentuofuMcGrawuHilluLL
C.
, orumanagement.
Estutime:u01-05
©uMcGrawuHilluLLC.uAllurightsureserved.uNoureproductionuorudistributionuwithoututheuprioruwrittenuconsentuofuMcGrawuHilluLL
C.
, 10. Managersuthatuareuinsulatedufromutakeoversumayubeumoreuproneutouagencyuproblemsuandutherefor
eumoreulikelyutouactuinutheiruownuinterestsuratheruthanuinushareholders‘.u Ifuaufirmuinstituteduaunewutak
eoverudefense,uweumightuexpectutouseeutheuvalueuofuitsusharesudeclineuasuagencyuproblemsuincrea
seuandulessushareholderuvalueumaximizationuoccurs.uTheucounterargumentuisuthatudefensiveumeas
uresuallowumanagersutounegotiateuforuauhigherupurchaseupriceuinutheufaceuofuautakeoverubid—
toutheubenefituofushareholderuvalue.
Estutime:u01-05
AppendixuQuestions:
1. Bothuwouldustilluinvestuinutheirufriend‘subusiness.uAuinvestsuandureceivesu$121,000uforuhisuinves
tmentuatutheuenduofutheuyear—
whichuisugreateruthanutheu$120,000uthatuwouldubeureceivedufromulendinguatu20%u($100,000u×u1
.20u=u$120,000).u Gualsouinvests,ubutuborrowsuagainstuthe
$121,000upayment,uanduthusureceivesu$100,833u($121,000u/u1.20)utoday.
Estutime:u01-05
2. a.uHeucoulduconsumeuuputou$200,000unowu(forgoinguallufutureuconsumption)uoruuputou$216,000une
xtuyearu($200,000u×u1.08,uforgoingualluconsumptionuthisuyear).uHeushoulduinvestualluofuhisuwealthutou
earnu$216,000unextu year.uTouchooseutheusameuconsumptionu(C)uinubothu years,uCu=u($200,000
–uC)u×u1.08u=u$103,846.
DollarsuNextuYear
220,000
216,000
203,704
200,000
DollarsuNow
b.uHeushoulduinvestualluofuhisuwealthutouearnu$220,000u($200,000u×u1.10)unextuyear.uIfuheuconsum
esualluthisuyear,uheucanunowuhaveuautotaluofu$203,703.70u($200,000u×u1.10/1.08)uthisuyearuoru$220,
000unextuyear.uIfuheuconsumesuCuthisuyear,utheuamountuavailableuforunextuyear‘suconsumptionuisu(
$203,703.70u–
uC)u×u1.08.uTougetuequaluconsumptionuinubothu years,usetutheuamountuconsumedutodayuequalutouth
euamountunextu year:
Cu=u($203,703.70u–uC)u×u1.08
Cu=u$105,769.20
Estutime:u06-10
©uMcGrawuHilluLLC.uAllurightsureserved.uNoureproductionuorudistributionuwithoututheuprioruwrittenuconsentuofuMcGrawuHilluLL
C.
IntroductionutouCorporateuFinance
Theuvaluesushownuinutheusolutionsumayubeuroundeduforudisplayupurposes.uHowever,utheuanswersuwereuderi
veduusinguauspreadsheetuwithoutuanyuintermediateurounding.
AnswersutouProblemuSets
1. a. real
b. executiveuairplanes
c. brandunames
d. financial
e. bonds
*f. investmentuorucapitaluexpenditure
*g. capitalubudgetinguoruinvestment
h. financing
*Noteuthatufuanduguareuinterchangeableuinutheuquestion.
Estutime:u01-05
2. Autrademark,uaufactory,uundevelopeduland,uanduyouruworkuforceu(c,ud,ue,uandug)uareuallurealuassets.u
Realuassetsuareuidentifiableuasuitemsuwithuintrinsicuvalue.uTheuothersuinutheulistuareufinancialuassets,u
thatuis,utheseuassetsuderiveuvalueubecauseuofuaucontractualuclaim.
Estutime:u01-05
3. a.
Financialuassets,usuchuasustocksuorubankuloans,uareuclaimsuheldubyuinvestors.uCor
porationsusellufinancialuassetsutouraiseutheucashutouinvestuinurealuassetsusuchuasuplantuand
uequipment.uSomeurealuassetsuareuintangible.
b. Capitaluexpenditureumeansuinvestmentuinurealuassets.uFinancingumeansuraisingutheucashu
foruthisuinvestment.
c. Theusharesuofupublicucorporationsuareutradeduonustockuexchangesuanducanubeupurchasedu
byuauwideurangeuofuinvestors.uTheusharesuofucloselyuhelducorporationsuareunotupubliclyutra
deduanduareuheldubyuausmallugroupuofuprivateuinvestors.
d. Unlimiteduliability:uInvestorsuareuresponsibleuforuallutheufirm‘sudebts.uAusoleuproprietoruhas
unlimiteduliability.uInvestorsuinucorporationsuhaveulimiteduliability.uTheyucanuloseutheiruinv
u
estment,ubutunoumore.
Estutime:u01-05
©uMcGrawuHilluLLC.uAllurightsureserved.uNoureproductionuorudistributionuwithoututheuprioruwrittenuconsentuofuMcGrawuHilluLL
C.
,4. Itemsucuanduduapplyutoucorporations.uBecauseucorporationsuhaveuperpetualulife,uownershipucanubeu
transferreduwithoutuaffectinguoperations,uandumanagersucanubeufireduwithunoueffectuonuownership.u
Otheruformsuofubusinessumayuhaveuunlimiteduliabilityuandulimitedulife.
Estutime:u01-05
5. Separationuofuownershipufacilitatesutheukeyuattributesuofuaucorporation,uincludingulimiteduliabilityuforu
investors,utransferabilityuofuownership,uauseparateulegalupersonalityuofutheucorporation,uandudelega
teducentralizedumanagement.uTheseufouruattributesuprovideusubstantialubenefituforuinvestors,uinclu
dingutheuabilityutoudiversifyutheiruinvestmentuamongumanyuuncorrelatedureturns—
auveryuvaluableutooluexploreduinulateruchapters.uAlso,utheseuattributesuallowuinvestorsutouquicklyuexi
t,uenter,uorushortuselluanuinvestment,utherebyugeneratinguanuactiveuliquidumarketuforucorporations.
However,utheseupositiveuaspectsualsouintroduceusubstantialunegativeuexternalitiesuasuwell.uTheuse
parationuofuownershipufromumanagementutypicallyuleadsutouagencyuproblems,uwhereumanagersupr
eferutouconsumeuprivateuperksuorumakeuotherudecisionsuforutheiruprivateubenefit—
ratheruthanumaximizeushareholderuwealth.uShareholdersutendutouexerciseulessuoversightuofueachui
ndividualuinvestmentuasutheirudiversificationuincreases.uFinally,utheucorporation‘suseparateulegalup
ersonalityumakesuitudifficultutouenforceuaccountabilityuifutheyuexternalizeucostsuontousociety.
Estutime:u01-05
6. Shareholdersuwilluonlyuvoteutoumaximizeushareholderuwealth.uShareholdersucanumodifyutheirup
atternuofuconsumptionuthroughuborrowinguandulending,umatchuriskupreferences,uanduhopefullyub
alanceutheiruownucheckbooksu(oruhireuauqualifieduprofessionalutouhelputhemuwithutheseutasks).
Estutime:u01-05
7. Ifutheuinvestmentuincreasesutheufirm‘suwealth,uituincreasesutheufirm‘sushareuvalue.u Ms.uEspinozau
coulduthenusellusomeuoruallutheseumoreuvaluableusharesutouprovideuforuheruretirementuincome.
Estutime:u01-05
8. a.
Assuminguthatutheuencabulatorumarketuisurisky,uanu8%uexpecteduret
urnuonutheuF&Huencabulatoruinvestmentsumayubeuinferiorutouau4%ureturnuo
nuU.S.
governmentusecurities,udependinguonutheurelativeuriskubetweenutheutwouassets.
b.
UnlessutheufinancialuassetsuareuasusafeuasuU.S.ugovernmentusecurities,utheirucostuofu
capitaluwouldubeuhigher.uTheuCFOucoulduconsideruexpectedureturnsuonuassetsuwithusimilarur
isk.
Estutime:u06-10
9. Managersuwoulduactuinushareholders‘uinterestsubecauseutheyuhaveuaulegaludutyutouactuinutheiruintere
sts.uManagersumayualsoureceiveucompensation—
ubonuses,ustock,uanduoptionupayoutsuwithuvalueutiedu(roughly)utoufirm uperformance.uManagersumayu
fearupersonalureputationaludamageufromunotuactinguinushareholders‘uinterests.uAndumanagersucanu
beufiredubyutheuboarduofudirectorsu(electedubyushareholders).u Ifumanagersustillufailutouactuinusharehol
ders‘uinterests,ushareholdersumayusellutheirushares,uloweringutheustockupriceuandupotentiallyucreatin
gutheupossibilityuofuautakeover,uwhichucanuagainuleadutouchangesuinutheuboarduofudirectorsuanduseni
©uMcGrawuHilluLLC.uAllurightsureserved.uNoureproductionuorudistributionuwithoututheuprioruwrittenuconsentuofuMcGrawuHilluLL
C.
, orumanagement.
Estutime:u01-05
©uMcGrawuHilluLLC.uAllurightsureserved.uNoureproductionuorudistributionuwithoututheuprioruwrittenuconsentuofuMcGrawuHilluLL
C.
, 10. Managersuthatuareuinsulatedufromutakeoversumayubeumoreuproneutouagencyuproblemsuandutherefor
eumoreulikelyutouactuinutheiruownuinterestsuratheruthanuinushareholders‘.u Ifuaufirmuinstituteduaunewutak
eoverudefense,uweumightuexpectutouseeutheuvalueuofuitsusharesudeclineuasuagencyuproblemsuincrea
seuandulessushareholderuvalueumaximizationuoccurs.uTheucounterargumentuisuthatudefensiveumeas
uresuallowumanagersutounegotiateuforuauhigherupurchaseupriceuinutheufaceuofuautakeoverubid—
toutheubenefituofushareholderuvalue.
Estutime:u01-05
AppendixuQuestions:
1. Bothuwouldustilluinvestuinutheirufriend‘subusiness.uAuinvestsuandureceivesu$121,000uforuhisuinves
tmentuatutheuenduofutheuyear—
whichuisugreateruthanutheu$120,000uthatuwouldubeureceivedufromulendinguatu20%u($100,000u×u1
.20u=u$120,000).u Gualsouinvests,ubutuborrowsuagainstuthe
$121,000upayment,uanduthusureceivesu$100,833u($121,000u/u1.20)utoday.
Estutime:u01-05
2. a.uHeucoulduconsumeuuputou$200,000unowu(forgoinguallufutureuconsumption)uoruuputou$216,000une
xtuyearu($200,000u×u1.08,uforgoingualluconsumptionuthisuyear).uHeushoulduinvestualluofuhisuwealthutou
earnu$216,000unextu year.uTouchooseutheusameuconsumptionu(C)uinubothu years,uCu=u($200,000
–uC)u×u1.08u=u$103,846.
DollarsuNextuYear
220,000
216,000
203,704
200,000
DollarsuNow
b.uHeushoulduinvestualluofuhisuwealthutouearnu$220,000u($200,000u×u1.10)unextuyear.uIfuheuconsum
esualluthisuyear,uheucanunowuhaveuautotaluofu$203,703.70u($200,000u×u1.10/1.08)uthisuyearuoru$220,
000unextuyear.uIfuheuconsumesuCuthisuyear,utheuamountuavailableuforunextuyear‘suconsumptionuisu(
$203,703.70u–
uC)u×u1.08.uTougetuequaluconsumptionuinubothu years,usetutheuamountuconsumedutodayuequalutouth
euamountunextu year:
Cu=u($203,703.70u–uC)u×u1.08
Cu=u$105,769.20
Estutime:u06-10
©uMcGrawuHilluLLC.uAllurightsureserved.uNoureproductionuorudistributionuwithoututheuprioruwrittenuconsentuofuMcGrawuHilluLL
C.
