Solutions Manual l
For
Corporate Finance l
Ross, Westerfield, Jaffe and Jordan
l l l l
13th edition l l
Prepared by: l
Brad Jordan l
Joe Smolira
l l
All Chapters Solutions Manual Supplement files download
l l l l l l
link at the end of this file.
l l l l l l l
, CHAPTER 2 - 2
CHAPTER 1 l
INTRODUCTION TO CORPORATE l l
FINANCE
l
Answers to Concept Questions l l l
1. In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders electthe
l l l l l l l l l l l l l l l l l
directors of the corporation, who in turn appoint the firm’s management. This separation of ownership
l l l l l l l l l l l l l l l
from control in the corporate form of organization is what causes agency problems to exist.Management
l l l l l l l l l l l l l l l l
may act in its own or someone else’s best interests, rather than those of the shareholders. If such events
l l l l l l l l l l l l l l l l l l l
occur, they may contradict the goal of maximizing the share price of the equity of the firm.
l l l l l l l l l l l l l l l l l
2. Such organizations frequently pursue social or political missions, so many different goals are
l l l l l l l l l l l l
conceivable. One goal that is often cited is revenue minimization; i.e., provide whatever goods and
l l l l l l l l l l l l l l l
services are offered at the lowest possible cost to society. A better approach might be to observe that even
l l l l l l l l l l l l l l l l l l l
a not-for-profit business has equity. Thus, one answer is that the appropriate goal is to maximizethe value
l l l l l l l l l l l l l l l l l l
of the equity.
l l l
3. Presumably, the current stock value reflects the risk, timing, and magnitude of all future cash flows, both l l l l l l l l l l l l l l l l
short-term and long-term. If this is correct, then the statement is false.
l l l l l l l l l l l l
4. An argument can be made either way. At the one extreme, we could argue that in a market economy,all of
l l l l l l l l l l l l l l l l l l l l
these things are priced. There is thus an optimal level of, for example, ethical and/or illegal behavior, and
l l l l l l l l l l l l l l l l l l
the framework of stock valuation explicitly includes these. At the other extreme, we could argue that these
l l l l l l l l l l l l l l l l l
are non-economic phenomena and are best handled through the political process. A classic (and highly
l l l l l l l l l l l l l l l
relevant) thought question that illustrates this debate goes something like this: “A firm has estimated that
l l l l l l l l l l l l l l l l
the cost of improving the safety of one of its products is $30 million. However, the firm believes that
l l l l l l l l l l l l l l l l l l l
improving the safety of the product will only save $20 million in product liability claims. What should
l l l l l l l l l l l l l l l l l
the firm do?”
l l l
5. The goal will be the same, but the best course of action toward that goal may be different because of
l l l l l l l l l l l l l l l l l l l
differing social, political, and economic institutions.
l l l l l l
6. The goal of management should be to maximize the share price for the current shareholders. If
l l l l l l l l l l l l l l l
management believes that itcan improve the profitability of thefirmso that the share price will exceed
l l l l l l l l l l l l l l l l l l
$35, then they should fight the offer from the outside company. If management believes that this bidder,
l l l l l l l l l l l l l l l l
or other unidentified bidders, will actually pay more than $35 per share to acquire the company, then they
l l l l l l l l l l l l l l l l l l
should still fight the offer. However, if the current management cannot increase the value of the firm
l l l l l l l l l l l l l l l l l
beyond the bid price, and no other higher bids come in, then management is not acting in theinterests of
l l l l l l l l l l l l l l l l l l l l
the shareholders by fighting the offer. Since current managers often lose their jobs when the corporation
l l l l l l l l l l l l l l l l
is acquired, poorly monitored managers have an incentive to fight corporate takeoversin situations such as
l l l l l l l l l l l l l l l l
this.
l
, CHAPTER 2 - 3
7. We would expect agency problems to be less severe in other countries, primarily due to the relatively
l l l l l l l l l l l l l l l l
small percentage of individual ownership. Fewer individual owners should reduce the number of diverse
l l l l l l l l l l l l l l
opinions concerning corporate goals. The high percentage of institutional ownership might lead to a
l l l l l l l l l l l l l l
higher degree of agreement between owners and managers on decisions concerning risky projects. In
l l l l l l l l l l l l l l
addition, institutions may be better able to implement effective monitoring mechanisms on managers
l l l l l l l l l l l l l
than can individual owners, based on the institutions’ deeper resources and experiences with their own
l l l l l l l l l l l l l l l
management.
l
8. The increase in institutional ownership of stock in the United States and the growing activism of theselarge
l l l l l l l l l l l l l l l l l
shareholder groups may lead to a reduction in agency problems for U.S. corporations and a moreefficient
l l l l l l l l l l l l l l l l l
market for corporate control. However, this may not always be the case. If the managers of the mutual
l l l l l l l l l l l l l l l l l l
fund or pension plan are not concerned with the interests of the investors, the agency problem could
l l l l l l l l l l l l l l l l l
potentially remain the same, or even increase, since there is the possibility of agency problems between
l l l l l l l l l l l l l l l l
the fund and its investors.
l l l l l
9. How much is too much? Who is worth more, Larry Ellison or Tiger Woods? The simplest answer is that
l l l l l l l l l l l l l l l l l l
there is a market for executives just as there is for all types of labor. Executive compensation is the price
l l l l l l l l l l l l l l l l l l l l
that clears the market. The same is true for athletes and performers. Having said that, one aspect of
l l l l l l l l l l l l l l l l l l
executive compensation deserves comment. A primary reason executive compensation has grown so
l l l l l l l l l l l l
dramatically is that companies have increasingly moved to stock-based compensation. Suchmovement is
l l l l l l l l l l l l l
obviously consistent with the attempt to better align stockholder and management interests. In recent
l l l l l l l l l l l l l l
years, stock prices have soared, so management has cleaned up. It is sometimes argued that much of this
l l l l l l l l l l l l l l l l l l
reward is due to rising stock prices in general, not managerial performance. Perhaps in the future,
l l l l l l l l l l l l l l l l
executive compensation will be designed to reward only differential performance, i.e., stock price
l l l l l l l l l l l l l
increases in excess of general market increases.
l l l l l l l
10. Maximizing the current share price is the same as maximizing the future share price at any future period. l l l l l l l l l l l l l l l l l
The value of a share of stock depends on all of the future cash flows of company. Another wayto look at this
l l l l l l l l l l l l l l l l l l l l l l l
is that, barring large cash payments to shareholders, the expected price of the stock must be higher in the
l l l l l l l l l l l l l l l l l l l
future than it is today. Who would buy a stock for $100 today when the share price inone year is expected
l l l l l l l l l l l l l l l l l l l l l l
to be $80?
l l l
, CHAPTER 2 l
FINANCIAL STATEMENTS AND CASH l l l
FLOW
l
Answers to Concepts Review and Critical Thinking Questions
l l l l l l l
1. True. Every asset can be converted to cash at some price. However, when we are referring to a liquid
l l l l l l l l l l l l l l l l l l
asset, the added assumption that the asset can be quickly converted to cash at or near market value is
l l l l l l l l l l l l l l l l l l l
important.
l
2. The recognition and matching principles in financial accounting call for revenues, and the costs
l l l l l l l l l l l l l
associated with producing those revenues, to be “booked” when the revenue process is essentially
l l l l l l l l l l l l l l
complete, not necessarily when the cash is collected or bills are paid. Note that this way is not necessarily
l l l l l l l l l l l l l l l l l l l
correct; it’s the way accountants have chosen to do it.
l l l l l l l l l l
3. The bottom line number shows the change in the cash balance on the balance sheet. As such, it is not a
l l l l l l l l l l l l l l l l l l l l
useful number for analyzing a company.
l l l l l l
4. The major difference is the treatment of interest expense. The accounting statement of cash flows treats
l l l l l l l l l l l l l l l
interest as an operating cash flow, while the financial cash flows treat interest as a financing cash flow.
l l l l l l l l l l l l l l l l l l
The logic of the accounting statement of cash flows is that since interest appears on the income
l l l l l l l l l l l l l l l l l
statement, which shows the operations for the period, it is an operating cash flow. In reality, interest is a
l l l l l l l l l l l l l l l l l l l
financing expense, which results from the company’s choice of debt and equity. We will have more to
l l l l l l l l l l l l l l l l l
say about this in a later chapter. When comparing the two cash flow statements, the financial statement of
l l l l l l l l l l l l l l l l l l
cashflowsisa moreappropriatemeasureofthecompany’sperformancebecauseof its treatment of interest.
l l l l l l l l l l l l l l l l l
5. Market values can never be negative. Imagine a share of stock selling for –$20. This would mean that if
l l l l l l l l l l l l l l l l l l
you placed an order for 100 shares, you would get the stock along with a check for $2,000. How many
l l l l l l l l l l l l l l l l l l l l
shares do you want to buy? More generally, because of corporate and individual bankruptcy laws, net
l l l l l l l l l l l l l l l l
worth for a person or a corporation cannot be negative, implying that liabilities cannot exceed assets in
l l l l l l l l l l l l l l l l l
market value.
l l
6. For a successful company that is rapidly expanding, for example, capital outlays will be large, possibly
l l l l l l l l l l l l l l l
leading to negative cash flow from assets. In general, what matters is whether the money is spent wisely,
l l l l l l l l l l l l l l l l l l
not whether cash flow from assets is positive or negative.
l l l l l l l l l l
7. It’s probably not a good sign for an established company to have negative cash flow from operations,but it
l l l l l l l l l l l l l l l l l l
would be fairly ordinary for a start-up, so it depends.
l l l l l l l l l l
For
Corporate Finance l
Ross, Westerfield, Jaffe and Jordan
l l l l
13th edition l l
Prepared by: l
Brad Jordan l
Joe Smolira
l l
All Chapters Solutions Manual Supplement files download
l l l l l l
link at the end of this file.
l l l l l l l
, CHAPTER 2 - 2
CHAPTER 1 l
INTRODUCTION TO CORPORATE l l
FINANCE
l
Answers to Concept Questions l l l
1. In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders electthe
l l l l l l l l l l l l l l l l l
directors of the corporation, who in turn appoint the firm’s management. This separation of ownership
l l l l l l l l l l l l l l l
from control in the corporate form of organization is what causes agency problems to exist.Management
l l l l l l l l l l l l l l l l
may act in its own or someone else’s best interests, rather than those of the shareholders. If such events
l l l l l l l l l l l l l l l l l l l
occur, they may contradict the goal of maximizing the share price of the equity of the firm.
l l l l l l l l l l l l l l l l l
2. Such organizations frequently pursue social or political missions, so many different goals are
l l l l l l l l l l l l
conceivable. One goal that is often cited is revenue minimization; i.e., provide whatever goods and
l l l l l l l l l l l l l l l
services are offered at the lowest possible cost to society. A better approach might be to observe that even
l l l l l l l l l l l l l l l l l l l
a not-for-profit business has equity. Thus, one answer is that the appropriate goal is to maximizethe value
l l l l l l l l l l l l l l l l l l
of the equity.
l l l
3. Presumably, the current stock value reflects the risk, timing, and magnitude of all future cash flows, both l l l l l l l l l l l l l l l l
short-term and long-term. If this is correct, then the statement is false.
l l l l l l l l l l l l
4. An argument can be made either way. At the one extreme, we could argue that in a market economy,all of
l l l l l l l l l l l l l l l l l l l l
these things are priced. There is thus an optimal level of, for example, ethical and/or illegal behavior, and
l l l l l l l l l l l l l l l l l l
the framework of stock valuation explicitly includes these. At the other extreme, we could argue that these
l l l l l l l l l l l l l l l l l
are non-economic phenomena and are best handled through the political process. A classic (and highly
l l l l l l l l l l l l l l l
relevant) thought question that illustrates this debate goes something like this: “A firm has estimated that
l l l l l l l l l l l l l l l l
the cost of improving the safety of one of its products is $30 million. However, the firm believes that
l l l l l l l l l l l l l l l l l l l
improving the safety of the product will only save $20 million in product liability claims. What should
l l l l l l l l l l l l l l l l l
the firm do?”
l l l
5. The goal will be the same, but the best course of action toward that goal may be different because of
l l l l l l l l l l l l l l l l l l l
differing social, political, and economic institutions.
l l l l l l
6. The goal of management should be to maximize the share price for the current shareholders. If
l l l l l l l l l l l l l l l
management believes that itcan improve the profitability of thefirmso that the share price will exceed
l l l l l l l l l l l l l l l l l l
$35, then they should fight the offer from the outside company. If management believes that this bidder,
l l l l l l l l l l l l l l l l
or other unidentified bidders, will actually pay more than $35 per share to acquire the company, then they
l l l l l l l l l l l l l l l l l l
should still fight the offer. However, if the current management cannot increase the value of the firm
l l l l l l l l l l l l l l l l l
beyond the bid price, and no other higher bids come in, then management is not acting in theinterests of
l l l l l l l l l l l l l l l l l l l l
the shareholders by fighting the offer. Since current managers often lose their jobs when the corporation
l l l l l l l l l l l l l l l l
is acquired, poorly monitored managers have an incentive to fight corporate takeoversin situations such as
l l l l l l l l l l l l l l l l
this.
l
, CHAPTER 2 - 3
7. We would expect agency problems to be less severe in other countries, primarily due to the relatively
l l l l l l l l l l l l l l l l
small percentage of individual ownership. Fewer individual owners should reduce the number of diverse
l l l l l l l l l l l l l l
opinions concerning corporate goals. The high percentage of institutional ownership might lead to a
l l l l l l l l l l l l l l
higher degree of agreement between owners and managers on decisions concerning risky projects. In
l l l l l l l l l l l l l l
addition, institutions may be better able to implement effective monitoring mechanisms on managers
l l l l l l l l l l l l l
than can individual owners, based on the institutions’ deeper resources and experiences with their own
l l l l l l l l l l l l l l l
management.
l
8. The increase in institutional ownership of stock in the United States and the growing activism of theselarge
l l l l l l l l l l l l l l l l l
shareholder groups may lead to a reduction in agency problems for U.S. corporations and a moreefficient
l l l l l l l l l l l l l l l l l
market for corporate control. However, this may not always be the case. If the managers of the mutual
l l l l l l l l l l l l l l l l l l
fund or pension plan are not concerned with the interests of the investors, the agency problem could
l l l l l l l l l l l l l l l l l
potentially remain the same, or even increase, since there is the possibility of agency problems between
l l l l l l l l l l l l l l l l
the fund and its investors.
l l l l l
9. How much is too much? Who is worth more, Larry Ellison or Tiger Woods? The simplest answer is that
l l l l l l l l l l l l l l l l l l
there is a market for executives just as there is for all types of labor. Executive compensation is the price
l l l l l l l l l l l l l l l l l l l l
that clears the market. The same is true for athletes and performers. Having said that, one aspect of
l l l l l l l l l l l l l l l l l l
executive compensation deserves comment. A primary reason executive compensation has grown so
l l l l l l l l l l l l
dramatically is that companies have increasingly moved to stock-based compensation. Suchmovement is
l l l l l l l l l l l l l
obviously consistent with the attempt to better align stockholder and management interests. In recent
l l l l l l l l l l l l l l
years, stock prices have soared, so management has cleaned up. It is sometimes argued that much of this
l l l l l l l l l l l l l l l l l l
reward is due to rising stock prices in general, not managerial performance. Perhaps in the future,
l l l l l l l l l l l l l l l l
executive compensation will be designed to reward only differential performance, i.e., stock price
l l l l l l l l l l l l l
increases in excess of general market increases.
l l l l l l l
10. Maximizing the current share price is the same as maximizing the future share price at any future period. l l l l l l l l l l l l l l l l l
The value of a share of stock depends on all of the future cash flows of company. Another wayto look at this
l l l l l l l l l l l l l l l l l l l l l l l
is that, barring large cash payments to shareholders, the expected price of the stock must be higher in the
l l l l l l l l l l l l l l l l l l l
future than it is today. Who would buy a stock for $100 today when the share price inone year is expected
l l l l l l l l l l l l l l l l l l l l l l
to be $80?
l l l
, CHAPTER 2 l
FINANCIAL STATEMENTS AND CASH l l l
FLOW
l
Answers to Concepts Review and Critical Thinking Questions
l l l l l l l
1. True. Every asset can be converted to cash at some price. However, when we are referring to a liquid
l l l l l l l l l l l l l l l l l l
asset, the added assumption that the asset can be quickly converted to cash at or near market value is
l l l l l l l l l l l l l l l l l l l
important.
l
2. The recognition and matching principles in financial accounting call for revenues, and the costs
l l l l l l l l l l l l l
associated with producing those revenues, to be “booked” when the revenue process is essentially
l l l l l l l l l l l l l l
complete, not necessarily when the cash is collected or bills are paid. Note that this way is not necessarily
l l l l l l l l l l l l l l l l l l l
correct; it’s the way accountants have chosen to do it.
l l l l l l l l l l
3. The bottom line number shows the change in the cash balance on the balance sheet. As such, it is not a
l l l l l l l l l l l l l l l l l l l l
useful number for analyzing a company.
l l l l l l
4. The major difference is the treatment of interest expense. The accounting statement of cash flows treats
l l l l l l l l l l l l l l l
interest as an operating cash flow, while the financial cash flows treat interest as a financing cash flow.
l l l l l l l l l l l l l l l l l l
The logic of the accounting statement of cash flows is that since interest appears on the income
l l l l l l l l l l l l l l l l l
statement, which shows the operations for the period, it is an operating cash flow. In reality, interest is a
l l l l l l l l l l l l l l l l l l l
financing expense, which results from the company’s choice of debt and equity. We will have more to
l l l l l l l l l l l l l l l l l
say about this in a later chapter. When comparing the two cash flow statements, the financial statement of
l l l l l l l l l l l l l l l l l l
cashflowsisa moreappropriatemeasureofthecompany’sperformancebecauseof its treatment of interest.
l l l l l l l l l l l l l l l l l
5. Market values can never be negative. Imagine a share of stock selling for –$20. This would mean that if
l l l l l l l l l l l l l l l l l l
you placed an order for 100 shares, you would get the stock along with a check for $2,000. How many
l l l l l l l l l l l l l l l l l l l l
shares do you want to buy? More generally, because of corporate and individual bankruptcy laws, net
l l l l l l l l l l l l l l l l
worth for a person or a corporation cannot be negative, implying that liabilities cannot exceed assets in
l l l l l l l l l l l l l l l l l
market value.
l l
6. For a successful company that is rapidly expanding, for example, capital outlays will be large, possibly
l l l l l l l l l l l l l l l
leading to negative cash flow from assets. In general, what matters is whether the money is spent wisely,
l l l l l l l l l l l l l l l l l l
not whether cash flow from assets is positive or negative.
l l l l l l l l l l
7. It’s probably not a good sign for an established company to have negative cash flow from operations,but it
l l l l l l l l l l l l l l l l l l
would be fairly ordinary for a start-up, so it depends.
l l l l l l l l l l
