Solution Manual For
Intermediate Financial Management
Author: Eugene Brigham
17th Edition
1- 1
© 2022 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
, Chapter 1
An Overview Of Financial Management And
The Financial Environment
ANSWERS TO BEGINNING-OF-CHAPTER QUESTIONS
1-1 The Primary Goal Is Assumed To Be Shareholder Wealth Maximization, Which Translates
To Stock Price Maximization. That, In Turn, Means Maximizing The PV Of Future Free
Cash Flows.
Maximizing Shareholder Wealth Requires That The Firm Produce Things That
Customers Want, And At The Lowest Cost Consistent With High Quality. It Also
Means Holding Risk Down, Which Will Result In A Relatively Low Cost Of Capital,
Which Is Necessary To Maximize The PV Of A Given Cash Flow Stream.
This Also Gets Into The Issue Of Capital Structure—How Much Debt Should We
Use? The More Debt The Firm Uses, The Lower Its Taxes, And The Fewer Shares
Outstanding, Hence Less Dilution Of Earnings. However, More Debt Means More
Risk. So, It’s Necessary To Consider Capital Structure When Attempting To Maximize
Share Prices.
Dividend Policy Is Also An Issue—How Much Of Its Earnings Should The Firm Pay
Out As Dividends? The Answer To That Question Depends On A Number Of Factors,
Including The Firm’s Investment Opportunities, Its Access To Capital Markets, Its
Stockholders’ Desires (And Their Tax Rates), And The Kind Of Signals Stockholders Get
From Dividend Actions.
Shareholder Wealth Maximization Is Partially Consistent And Partially
Inconsistent With Generally Accepted Societal Goals. It Is Consistent Because Well-Run
Firms Produce Good Products At Low Costs, Sell Them At Competitive Prices, Employ
People, Pay Taxes, And Generally Improve Society. However, Without Constraints, Firms
Would Tend To Form Monopolies And End Up Charging Prices That Are Too High
And Not Producing Enough Output. They Might Also Pollute The Air And Water,
Engage In Unfair Labor Practices, And So On. So, Constraints (Antitrust, Labor,
Environmental, Etc. Laws) Should Be And Are Imposed On Businesses. That Said,
Stock Price Maximization Is Consistent With A Strong Economy, Economic
Progress, And ―The Good Life‖ For Most Citizens.
In Standard Introductory Microeconomics Courses, We Assume That Firms Attempt
To Maximize Profits. In More Advanced Econ Courses, The Goal Is Broadened To Value
Maximizing, So Finance And Economics Are Indeed Consistent.
As Worldcom, Enron, And Other Corporate Scandals Demonstrated Very Clearly,
Managers Do Not Always Have Stockholders’ Interests As A Primary Goal—Some
Managers Have Their Own Interests. This Point Is Discussed Further Below.
1- 1
© 2022 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
,1-2 See The Model For Quantitative Answers To This Question. All Of These Valuations
Involve Applications Of The Basic Valuation Model:
Value = Cft .
© 2022 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
, N
T=0 (1 + R) T
Values For Cft , R, And N Are Specified. For Bonds, The Cfs Are Interest Payments And
The Maturity Value, And N Is The Bond’s Life. Other Things Held Constant, The Higher
The Going Interest Rate, R, The Lower The Value Of The Bond. Also, If The Coupon
Rate Is High, Then Cfs Are Also High, And That Increases The Value Of The Bond.
For A Stock, The Cfs Are Dividends, And For A Capital Budgeting Project, They Are
Operating Cash Flows.
The Main Point To Get Across With This Question Is That All Assets Are Valued In
Essentially The Same Way. The Excel Model Goes Into A Little More Detail On
Sensitivity Analysis. Much More Comes Later In The Book.
1-3 The Advantages Of A Corporate Form Of Ownership Are That Investor Liability Is
Limited To The Amount Invested, Corporations Can Raise Capital Through Public
Offerings Of Stock, And Ownership Can Be Easily Transferred From Person To Person
By Simply Selling Shares Of Stock. In A Sole Proprietorship Or Partnership, On The
Other Hand, The Owner Or Owners Are Exposed To Potentially Unlimited Liability, It Is
Difficult To Raise Equity Capital Since Either New Partners Must Be Found Or The
Existing Partners Must Put Up Additional Capital, And It Is Difficult To Transfer
Ownership Between Partners Or From A Sole Proprietor To Someone Else.
The Disadvantages Of The Corporate Form Are That There Are Numerous Forms That
Must Be Filled Out And Regulations That Must Be Followed That Are Not Required Of A
Sole Proprietorship Or A Partnership, Corporations Are Subject To Double Taxation Of
Distributed Earnings In That The Corporation First Pays Taxes On The Pre-Tax Income,
And Then The Owners Must Pay Tax On The Dividend Or Capital Gains Income, And
The Separation Of Ownership (By The Shareholders) And Control (By Management) Can
Result In Management Taking Actions That Are Not In The Owners’ Best Interests.
1-4 The Cost Of Money Is Affected By (1) Production Opportunities, (2) The Time
Preference For Consumption, (3) Risk, And (4) Inflation. When Production Opportunities
Are Good, And Assets Are Earning High Rates Of Return, Then Interest Rates Tend To
Be Higher Because There Is A Larger Demand For Borrowing To Finance These Projects.
Also, Investors Who Are Considering Lending Money Recognize That Their Alternative
Investments Have A High Return, And So Demand A High Return On Their
Investments. When Investors Have A Strong Preference For Current Consumption, Then
They Demand A Higher Return On Their Investments To Compensate Them For Having
To Defer Current Purchases, And So The Cost Of Money Is Higher. Investors Demand A
Higher Rate Of Return On Riskier Investments In Order To Compensate Them For The
Having To Be Exposed To More Risk, And When Investors Expect Future Inflation, Then
The Cost Of Money Increases So That Investment Returns Better Cover This Future Price
Increase.
If Any Of These Factors Change, Then The Cost Of Money Will Change, And Hence
The Yield And The Price Of A Security Will Change As Well. For Example, If Overall
The Time Preference For Consumption Increases, Then Overall Interest Rates Will Tend
To Increase And The Yield On Debt Instruments Will Tend To Increase, And Their
© 2022 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Intermediate Financial Management
Author: Eugene Brigham
17th Edition
1- 1
© 2022 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
, Chapter 1
An Overview Of Financial Management And
The Financial Environment
ANSWERS TO BEGINNING-OF-CHAPTER QUESTIONS
1-1 The Primary Goal Is Assumed To Be Shareholder Wealth Maximization, Which Translates
To Stock Price Maximization. That, In Turn, Means Maximizing The PV Of Future Free
Cash Flows.
Maximizing Shareholder Wealth Requires That The Firm Produce Things That
Customers Want, And At The Lowest Cost Consistent With High Quality. It Also
Means Holding Risk Down, Which Will Result In A Relatively Low Cost Of Capital,
Which Is Necessary To Maximize The PV Of A Given Cash Flow Stream.
This Also Gets Into The Issue Of Capital Structure—How Much Debt Should We
Use? The More Debt The Firm Uses, The Lower Its Taxes, And The Fewer Shares
Outstanding, Hence Less Dilution Of Earnings. However, More Debt Means More
Risk. So, It’s Necessary To Consider Capital Structure When Attempting To Maximize
Share Prices.
Dividend Policy Is Also An Issue—How Much Of Its Earnings Should The Firm Pay
Out As Dividends? The Answer To That Question Depends On A Number Of Factors,
Including The Firm’s Investment Opportunities, Its Access To Capital Markets, Its
Stockholders’ Desires (And Their Tax Rates), And The Kind Of Signals Stockholders Get
From Dividend Actions.
Shareholder Wealth Maximization Is Partially Consistent And Partially
Inconsistent With Generally Accepted Societal Goals. It Is Consistent Because Well-Run
Firms Produce Good Products At Low Costs, Sell Them At Competitive Prices, Employ
People, Pay Taxes, And Generally Improve Society. However, Without Constraints, Firms
Would Tend To Form Monopolies And End Up Charging Prices That Are Too High
And Not Producing Enough Output. They Might Also Pollute The Air And Water,
Engage In Unfair Labor Practices, And So On. So, Constraints (Antitrust, Labor,
Environmental, Etc. Laws) Should Be And Are Imposed On Businesses. That Said,
Stock Price Maximization Is Consistent With A Strong Economy, Economic
Progress, And ―The Good Life‖ For Most Citizens.
In Standard Introductory Microeconomics Courses, We Assume That Firms Attempt
To Maximize Profits. In More Advanced Econ Courses, The Goal Is Broadened To Value
Maximizing, So Finance And Economics Are Indeed Consistent.
As Worldcom, Enron, And Other Corporate Scandals Demonstrated Very Clearly,
Managers Do Not Always Have Stockholders’ Interests As A Primary Goal—Some
Managers Have Their Own Interests. This Point Is Discussed Further Below.
1- 1
© 2022 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
,1-2 See The Model For Quantitative Answers To This Question. All Of These Valuations
Involve Applications Of The Basic Valuation Model:
Value = Cft .
© 2022 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
, N
T=0 (1 + R) T
Values For Cft , R, And N Are Specified. For Bonds, The Cfs Are Interest Payments And
The Maturity Value, And N Is The Bond’s Life. Other Things Held Constant, The Higher
The Going Interest Rate, R, The Lower The Value Of The Bond. Also, If The Coupon
Rate Is High, Then Cfs Are Also High, And That Increases The Value Of The Bond.
For A Stock, The Cfs Are Dividends, And For A Capital Budgeting Project, They Are
Operating Cash Flows.
The Main Point To Get Across With This Question Is That All Assets Are Valued In
Essentially The Same Way. The Excel Model Goes Into A Little More Detail On
Sensitivity Analysis. Much More Comes Later In The Book.
1-3 The Advantages Of A Corporate Form Of Ownership Are That Investor Liability Is
Limited To The Amount Invested, Corporations Can Raise Capital Through Public
Offerings Of Stock, And Ownership Can Be Easily Transferred From Person To Person
By Simply Selling Shares Of Stock. In A Sole Proprietorship Or Partnership, On The
Other Hand, The Owner Or Owners Are Exposed To Potentially Unlimited Liability, It Is
Difficult To Raise Equity Capital Since Either New Partners Must Be Found Or The
Existing Partners Must Put Up Additional Capital, And It Is Difficult To Transfer
Ownership Between Partners Or From A Sole Proprietor To Someone Else.
The Disadvantages Of The Corporate Form Are That There Are Numerous Forms That
Must Be Filled Out And Regulations That Must Be Followed That Are Not Required Of A
Sole Proprietorship Or A Partnership, Corporations Are Subject To Double Taxation Of
Distributed Earnings In That The Corporation First Pays Taxes On The Pre-Tax Income,
And Then The Owners Must Pay Tax On The Dividend Or Capital Gains Income, And
The Separation Of Ownership (By The Shareholders) And Control (By Management) Can
Result In Management Taking Actions That Are Not In The Owners’ Best Interests.
1-4 The Cost Of Money Is Affected By (1) Production Opportunities, (2) The Time
Preference For Consumption, (3) Risk, And (4) Inflation. When Production Opportunities
Are Good, And Assets Are Earning High Rates Of Return, Then Interest Rates Tend To
Be Higher Because There Is A Larger Demand For Borrowing To Finance These Projects.
Also, Investors Who Are Considering Lending Money Recognize That Their Alternative
Investments Have A High Return, And So Demand A High Return On Their
Investments. When Investors Have A Strong Preference For Current Consumption, Then
They Demand A Higher Return On Their Investments To Compensate Them For Having
To Defer Current Purchases, And So The Cost Of Money Is Higher. Investors Demand A
Higher Rate Of Return On Riskier Investments In Order To Compensate Them For The
Having To Be Exposed To More Risk, And When Investors Expect Future Inflation, Then
The Cost Of Money Increases So That Investment Returns Better Cover This Future Price
Increase.
If Any Of These Factors Change, Then The Cost Of Money Will Change, And Hence
The Yield And The Price Of A Security Will Change As Well. For Example, If Overall
The Time Preference For Consumption Increases, Then Overall Interest Rates Will Tend
To Increase And The Yield On Debt Instruments Will Tend To Increase, And Their
© 2022 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
