CHAPTERg1
IntroductiongtogCorporategFinance
Thegvaluesgshowngingthegsolutionsgmaygbegroundedgforgdisplaygpurposes.gHowever,gtheganswersgwereg
derivedgusinggagspreadsheetgwithoutganygintermediategrounding.
AnswersgtogProblemgSets
1. a. real
b. executivegairplanes
c. brandgnames
d. financial
e. bonds
*f. investmentgorgcapitalgexpenditure
*g. capitalgbudgetinggorginvestment
h. financing
*Notegthatgfgandgggareginterchangeablegingthegquestion.
Estgtime:g01-05
2. Agtrademark,gagfactory,gundevelopedgland,gandgyourgworkgforceg(c,gd,ge,gandgg)garegallgrealgas
sets.gRealgassetsgaregidentifiablegasgitemsgwithgintrinsicgvalue.gThegothersgingtheglistgaregfinanci
algassets,gthatgis,gthesegassetsgderivegvaluegbecausegofgagcontractualgclaim.
Estgtime:g01-05
3. a.
Financialgassets,gsuchgasgstocksgorgbankgloans,garegclaimsgheldgbyginvestors.gC
orporationsgsellgfinancialgassetsgtograisegthegcashgtoginvestgingrealgassetsgsuchgasgpl
antgandgequipment.gSomegrealgassetsgaregintangible.
b. Capitalgexpendituregmeansginvestmentgingrealgassets.gFinancinggmeansgraisinggthegc
ashgforgthisginvestment.
c. Thegsharesgofgpublicgcorporationsgaregtradedgongstockgexchangesgandgcangbegpurcha
sedgbygagwidegrangegofginvestors.gThegsharesgofgcloselygheldgcorporationsgaregnotgpu
bliclygtradedgandgaregheldgbygagsmallggroupgofgprivateginvestors.
d. Unlimitedgliability:gInvestorsgaregresponsiblegforgallgthegfirm‘sgdebts.gAgsolegproprietorg
hasgunlimitedgliability.gInvestorsgingcorporationsghaveglimitedgliability.g Theygcanglosegt
heirginvestment,gbutgnogmore.
Estgtime:g01-05
©gMcGrawgHillgLLC.gAllgrightsgreserved.gNogreproductiongorgdistributiongwithoutgthegpriorgwrittengconsentgofgMcGrawgHil
lgLLC.
,4. Itemsgcgandgdgapplygtogcorporations.g Becausegcorporationsghavegperpetualglife,gownershipgcan
gbegtransferredgwithoutgaffectinggoperations,gandgmanagersgcangbegfiredgwithgnogeffectgongown
ership.gOthergformsgofgbusinessgmayghavegunlimitedgliabilitygandglimitedglife.
Estgtime:g01-05
5. Separationgofgownershipgfacilitatesgthegkeygattributesgofgagcorporation,gincludingglimitedgliability
gforginvestors,gtransferabilitygofgownership,gagseparateglegalgpersonalitygofgthegcorporation,gand
gdelegatedgcentralizedgmanagement.g Thesegfourgattributesgprovidegsubstantialgbenefitgforginve
stors,gincludinggthegabilitygtogdiversifygtheirginvestmentgamonggmanyguncorrelatedgreturns—
agverygvaluablegtoolgexploredginglatergchapters.g Also,gthesegattributesgallowginvestorsgtogquickl
ygexit,genter,gorgshortgsellganginvestment,gtherebyggeneratinggangactivegliquidgmarketgforgcorpor
ations.
However,gthesegpositivegaspectsgalsogintroducegsubstantialgnegativegexternalitiesgasgwell.g The
gseparationgofgownershipgfromgmanagementgtypicallygleadsgtogagencygproblems,gwheregmanag
ersgprefergtogconsumegprivategperksgorgmakegothergdecisionsgforgtheirgprivategbenefit—
rathergthangmaximizegshareholdergwealth.g Shareholdersgtendgtogexerciseglessgoversightgofgeac
hgindividualginvestmentgasgtheirgdiversificationgincreases.g Finally,gthegcorporation‘sgseparategle
galgpersonalitygmakesgitgdifficultgtogenforcegaccountabilitygifgtheygexternalizegcostsgontogsociety
.
Estgtime:g01-05
6. Shareholdersgwillgonlygvotegtogmaximizegshareholdergwealth.g Shareholdersgcangmodifygthe
irgpatterngofgconsumptiongthroughgborrowinggandglending,gmatchgriskgpreferences,gandghop
efullygbalancegtheirgowngcheckbooksg(orghiregagqualifiedgprofessionalgtoghelpgthemgwithgthe
segtasks).
Estgtime:g01-05
7. Ifgtheginvestmentgincreasesgthegfirm‘sgwealth,gitgincreasesgthegfirm‘sgsharegvalue.g Ms.gEspin
ozagcouldgthengsellgsomegorgallgthesegmoregvaluablegsharesgtogprovidegforghergretirementgin
come.
Estgtime:g01-05
8. a.
Assuminggthatgthegencabulatorgmarketgisgrisky,gang8%gexpectedgret
urngongthegF&Hgencabulatorginvestmentsgmaygbeginferiorgtogag4%gretur
ngongU.S.
governmentgsecurities,gdependinggongthegrelativegriskgbetweengthegtwogassets.
b. UnlessgthegfinancialgassetsgaregasgsafegasgU.S.ggovernmentgsecurities,gtheirgcostgofgca
pitalgwouldgbeghigher.gThegCFOgcouldgconsidergexpectedgreturnsgongassetsgwithgsimilar
grisk.
Estgtime:g06-10
9. Managersgwouldgactgingshareholders‘ginterestsgbecausegtheyghavegaglegalgdutygtogactgingtheirgi
nterests.g Managersgmaygalsogreceivegcompensation—
gbonuses,gstock,gandgoptiongpayoutsgwithgvaluegtiedg(roughly)gtogfirmgperformance.g Managersg
maygfeargpersonalgreputationalgdamagegfromgnotgactinggingshareholders‘ginterests.gAndgmanag
©gMcGrawgHillgLLC.gAllgrightsgreserved.gNogreproductiongorgdistributiongwithoutgthegpriorgwrittengconsentgofgMcGrawgHil
lgLLC.
, ersgcangbegfiredgbygthegboardgofgdirectorsg(electedgbygshareholders).g Ifgmanagersgstillgfailgtoga
ctgingshareholders‘ginterests,gshareholdersgmaygsellgtheirgshares,gloweringgthegstockgpricegandg
potentiallygcreatinggthegpossibilitygofgagtakeover,gwhichgcangagaingleadgtogchangesgingthegboard
gofgdirectorsgandgseniorgmanagement.
Estgtime:g01-05
©gMcGrawgHillgLLC.gAllgrightsgreserved.gNogreproductiongorgdistributiongwithoutgthegpriorgwrittengconsentgofgMcGrawgHil
lgLLC.
, 10. Managersgthatgareginsulatedgfromgtakeoversgmaygbegmoregpronegtogagencygproblemsgandgther
eforegmoreglikelygtogactgingtheirgownginterestsgrathergthangingshareholders‘.g Ifgagfirmginstitutedg
agnewgtakeovergdefense,gwegmightgexpectgtogseegthegvaluegofgitsgsharesgdeclinegasgagencyg p
roblemsgincreasegandglessgshareholdergvaluegmaximizationgoccurs.gThegcounterargumentgisgth
atgdefensivegmeasuresgallowgmanagersgtognegotiategforgaghighergpurchasegpricegingthegfacegof
gagtakeovergbid—togthegbenefitgofgshareholdergvalue.
Estgtime:g01-05
AppendixgQuestions:
1. Bothgwouldgstillginvestgingtheirgfriend‘sgbusiness.g Aginvestsgandgreceivesg$121,000gforghisgi
nvestmentgatgthegendgofgthegyear—
whichgisggreatergthangtheg$120,000gthatgwouldgbegreceivedgfromglendinggatg20%g($100,000
g×g1.20g=g$120,000).g Ggalsoginvests,gbutgborrowsgagainstgthe
$121,000gpayment,gandgthusgreceivesg$100,833g($121,000g/g1.20)gtoday.
Estgtime:g01-05
2. a.gHegcouldgconsumegupgtog$200,000gnowg(forgoinggallgfuturegconsumption)gorgupgtog$216,00
0gnextgyearg($200,000g×g1.08,gforgoinggallgconsumptiongthisgyear).gHegshouldginvestgallgofghisg
wealthgtogearng$216,000gnextgyear.g Togchoosegthegsamegconsumptiong(C)gingbothgyears,gCg=
g($200,000g–gC)g×g1.08g=g$103,846.
Dollarsg Nextg Year
220,000
216,000
203,704
200,000
Dollarsg Now
b. Hegshouldginvestgallgofghisgwealthgtogearng$220,000g($200,000g×g1.10)gnextgyear.g Ifghegco
nsumesgallgthisgyear,ghegcangnowghavegagtotalgofg$203,703.70g($200,000g×g1.10/1.08)gthisgye
argorg$220,000gnextgyear.g IfghegconsumesgCgthisgyear,gthegamountgavailablegforgnextgyear‘sg
consumptiongisg($203,703.70g–
gC)g×g1.08.g Toggetgequalgconsumptiongingbothgyears,gsetgthegamountgconsumedgtodaygequal
gtogthegamountgnextgyear:
Cg=g ($203,703.70g –g C)g ×g 1.08
Cg=g$105,769.20
Estgtime:g06-10
©gMcGrawgHillgLLC.gAllgrightsgreserved.gNogreproductiongorgdistributiongwithoutgthegpriorgwrittengconsentgofgMcGrawgHil
lgLLC.
IntroductiongtogCorporategFinance
Thegvaluesgshowngingthegsolutionsgmaygbegroundedgforgdisplaygpurposes.gHowever,gtheganswersgwereg
derivedgusinggagspreadsheetgwithoutganygintermediategrounding.
AnswersgtogProblemgSets
1. a. real
b. executivegairplanes
c. brandgnames
d. financial
e. bonds
*f. investmentgorgcapitalgexpenditure
*g. capitalgbudgetinggorginvestment
h. financing
*Notegthatgfgandgggareginterchangeablegingthegquestion.
Estgtime:g01-05
2. Agtrademark,gagfactory,gundevelopedgland,gandgyourgworkgforceg(c,gd,ge,gandgg)garegallgrealgas
sets.gRealgassetsgaregidentifiablegasgitemsgwithgintrinsicgvalue.gThegothersgingtheglistgaregfinanci
algassets,gthatgis,gthesegassetsgderivegvaluegbecausegofgagcontractualgclaim.
Estgtime:g01-05
3. a.
Financialgassets,gsuchgasgstocksgorgbankgloans,garegclaimsgheldgbyginvestors.gC
orporationsgsellgfinancialgassetsgtograisegthegcashgtoginvestgingrealgassetsgsuchgasgpl
antgandgequipment.gSomegrealgassetsgaregintangible.
b. Capitalgexpendituregmeansginvestmentgingrealgassets.gFinancinggmeansgraisinggthegc
ashgforgthisginvestment.
c. Thegsharesgofgpublicgcorporationsgaregtradedgongstockgexchangesgandgcangbegpurcha
sedgbygagwidegrangegofginvestors.gThegsharesgofgcloselygheldgcorporationsgaregnotgpu
bliclygtradedgandgaregheldgbygagsmallggroupgofgprivateginvestors.
d. Unlimitedgliability:gInvestorsgaregresponsiblegforgallgthegfirm‘sgdebts.gAgsolegproprietorg
hasgunlimitedgliability.gInvestorsgingcorporationsghaveglimitedgliability.g Theygcanglosegt
heirginvestment,gbutgnogmore.
Estgtime:g01-05
©gMcGrawgHillgLLC.gAllgrightsgreserved.gNogreproductiongorgdistributiongwithoutgthegpriorgwrittengconsentgofgMcGrawgHil
lgLLC.
,4. Itemsgcgandgdgapplygtogcorporations.g Becausegcorporationsghavegperpetualglife,gownershipgcan
gbegtransferredgwithoutgaffectinggoperations,gandgmanagersgcangbegfiredgwithgnogeffectgongown
ership.gOthergformsgofgbusinessgmayghavegunlimitedgliabilitygandglimitedglife.
Estgtime:g01-05
5. Separationgofgownershipgfacilitatesgthegkeygattributesgofgagcorporation,gincludingglimitedgliability
gforginvestors,gtransferabilitygofgownership,gagseparateglegalgpersonalitygofgthegcorporation,gand
gdelegatedgcentralizedgmanagement.g Thesegfourgattributesgprovidegsubstantialgbenefitgforginve
stors,gincludinggthegabilitygtogdiversifygtheirginvestmentgamonggmanyguncorrelatedgreturns—
agverygvaluablegtoolgexploredginglatergchapters.g Also,gthesegattributesgallowginvestorsgtogquickl
ygexit,genter,gorgshortgsellganginvestment,gtherebyggeneratinggangactivegliquidgmarketgforgcorpor
ations.
However,gthesegpositivegaspectsgalsogintroducegsubstantialgnegativegexternalitiesgasgwell.g The
gseparationgofgownershipgfromgmanagementgtypicallygleadsgtogagencygproblems,gwheregmanag
ersgprefergtogconsumegprivategperksgorgmakegothergdecisionsgforgtheirgprivategbenefit—
rathergthangmaximizegshareholdergwealth.g Shareholdersgtendgtogexerciseglessgoversightgofgeac
hgindividualginvestmentgasgtheirgdiversificationgincreases.g Finally,gthegcorporation‘sgseparategle
galgpersonalitygmakesgitgdifficultgtogenforcegaccountabilitygifgtheygexternalizegcostsgontogsociety
.
Estgtime:g01-05
6. Shareholdersgwillgonlygvotegtogmaximizegshareholdergwealth.g Shareholdersgcangmodifygthe
irgpatterngofgconsumptiongthroughgborrowinggandglending,gmatchgriskgpreferences,gandghop
efullygbalancegtheirgowngcheckbooksg(orghiregagqualifiedgprofessionalgtoghelpgthemgwithgthe
segtasks).
Estgtime:g01-05
7. Ifgtheginvestmentgincreasesgthegfirm‘sgwealth,gitgincreasesgthegfirm‘sgsharegvalue.g Ms.gEspin
ozagcouldgthengsellgsomegorgallgthesegmoregvaluablegsharesgtogprovidegforghergretirementgin
come.
Estgtime:g01-05
8. a.
Assuminggthatgthegencabulatorgmarketgisgrisky,gang8%gexpectedgret
urngongthegF&Hgencabulatorginvestmentsgmaygbeginferiorgtogag4%gretur
ngongU.S.
governmentgsecurities,gdependinggongthegrelativegriskgbetweengthegtwogassets.
b. UnlessgthegfinancialgassetsgaregasgsafegasgU.S.ggovernmentgsecurities,gtheirgcostgofgca
pitalgwouldgbeghigher.gThegCFOgcouldgconsidergexpectedgreturnsgongassetsgwithgsimilar
grisk.
Estgtime:g06-10
9. Managersgwouldgactgingshareholders‘ginterestsgbecausegtheyghavegaglegalgdutygtogactgingtheirgi
nterests.g Managersgmaygalsogreceivegcompensation—
gbonuses,gstock,gandgoptiongpayoutsgwithgvaluegtiedg(roughly)gtogfirmgperformance.g Managersg
maygfeargpersonalgreputationalgdamagegfromgnotgactinggingshareholders‘ginterests.gAndgmanag
©gMcGrawgHillgLLC.gAllgrightsgreserved.gNogreproductiongorgdistributiongwithoutgthegpriorgwrittengconsentgofgMcGrawgHil
lgLLC.
, ersgcangbegfiredgbygthegboardgofgdirectorsg(electedgbygshareholders).g Ifgmanagersgstillgfailgtoga
ctgingshareholders‘ginterests,gshareholdersgmaygsellgtheirgshares,gloweringgthegstockgpricegandg
potentiallygcreatinggthegpossibilitygofgagtakeover,gwhichgcangagaingleadgtogchangesgingthegboard
gofgdirectorsgandgseniorgmanagement.
Estgtime:g01-05
©gMcGrawgHillgLLC.gAllgrightsgreserved.gNogreproductiongorgdistributiongwithoutgthegpriorgwrittengconsentgofgMcGrawgHil
lgLLC.
, 10. Managersgthatgareginsulatedgfromgtakeoversgmaygbegmoregpronegtogagencygproblemsgandgther
eforegmoreglikelygtogactgingtheirgownginterestsgrathergthangingshareholders‘.g Ifgagfirmginstitutedg
agnewgtakeovergdefense,gwegmightgexpectgtogseegthegvaluegofgitsgsharesgdeclinegasgagencyg p
roblemsgincreasegandglessgshareholdergvaluegmaximizationgoccurs.gThegcounterargumentgisgth
atgdefensivegmeasuresgallowgmanagersgtognegotiategforgaghighergpurchasegpricegingthegfacegof
gagtakeovergbid—togthegbenefitgofgshareholdergvalue.
Estgtime:g01-05
AppendixgQuestions:
1. Bothgwouldgstillginvestgingtheirgfriend‘sgbusiness.g Aginvestsgandgreceivesg$121,000gforghisgi
nvestmentgatgthegendgofgthegyear—
whichgisggreatergthangtheg$120,000gthatgwouldgbegreceivedgfromglendinggatg20%g($100,000
g×g1.20g=g$120,000).g Ggalsoginvests,gbutgborrowsgagainstgthe
$121,000gpayment,gandgthusgreceivesg$100,833g($121,000g/g1.20)gtoday.
Estgtime:g01-05
2. a.gHegcouldgconsumegupgtog$200,000gnowg(forgoinggallgfuturegconsumption)gorgupgtog$216,00
0gnextgyearg($200,000g×g1.08,gforgoinggallgconsumptiongthisgyear).gHegshouldginvestgallgofghisg
wealthgtogearng$216,000gnextgyear.g Togchoosegthegsamegconsumptiong(C)gingbothgyears,gCg=
g($200,000g–gC)g×g1.08g=g$103,846.
Dollarsg Nextg Year
220,000
216,000
203,704
200,000
Dollarsg Now
b. Hegshouldginvestgallgofghisgwealthgtogearng$220,000g($200,000g×g1.10)gnextgyear.g Ifghegco
nsumesgallgthisgyear,ghegcangnowghavegagtotalgofg$203,703.70g($200,000g×g1.10/1.08)gthisgye
argorg$220,000gnextgyear.g IfghegconsumesgCgthisgyear,gthegamountgavailablegforgnextgyear‘sg
consumptiongisg($203,703.70g–
gC)g×g1.08.g Toggetgequalgconsumptiongingbothgyears,gsetgthegamountgconsumedgtodaygequal
gtogthegamountgnextgyear:
Cg=g ($203,703.70g –g C)g ×g 1.08
Cg=g$105,769.20
Estgtime:g06-10
©gMcGrawgHillgLLC.gAllgrightsgreserved.gNogreproductiongorgdistributiongwithoutgthegpriorgwrittengconsentgofgMcGrawgHil
lgLLC.
