ALL 20 CHAPTERS COVERED
,1-1 Titman/Keown/Martin • Financial Management, Thirteenth Edition, Global Edition
Chapter 1
Solutions to Study Questions
1-1. The solution to this problem is dependent upon the student’s experiences.
1-2. There are three basic types of issues that are addressed by the study of finance:
a. What long-term investments should the firm undertake? This area of finance is
generally referred to as capital budgeting.
b. How should the firm raise money to fund these investments? The firm’s funding
choices are generally referred to as capital structure decisions.
c. How can the firm best manage its cash flows as they arise in its day-to-day operations?
This area of finance is generally referred to as working capital management.
1-3. First, investors demand a minimum return for delaying consumption that must be greater
than the anticipated rate of inflation. If they didn’t receive enough to compensate for
anticipated inflation, investors would purchase whatever goods they desired ahead of time.
There isn’t much incentive to postpone consumption if your savings are going to decline in
terms of purchasing power.
Investment alternatives have different amounts of risk and expected returns. Investors
sometimes choose to put their money in risky investments because these investments offer
higher expected returns. The more risk an investment has, the higher will be its expected
return – that’s because risk investors don’t like risk, in particular, they don’t like the chance
that they might lose their money. That makes risky investments less attractive, which
means that to attract investors, riskier investments must be priced to offer investors a higher
expected rate of return. This relationship between risk and expected return is shown in
Figure 1.3.
Notice that we keep referring to expected return rather than actual return. We may have
expectations of what the returns for investing will be, but we can’t peer into the future and
see what those returns are actually going to be. Until after the fact, you are never sure what
the return on an investment will be. That is why General Motors bonds pay more interest
than U.S. Treasury bonds of the same maturity. The additional interest induces some
investors to take on the added risk of purchasing a General Motors bond.
1-4. Incremental cash flows describe the total cash effect on a company. This involves assessing
the difference between total cash flow to the company with the cash flow, and without the
cash flow. A company can then value these cash flows to see if it is worth more with the
project or without it.
1-5. The three business forms are:
1. Sole Proprietorship.
2. Partnership.
3. Corporation.
Copyright © 2018 Pearson Education Ltd.
,1-2 Titman/Keown/Martin • Financial Management, Thirteenth Edition, Global Edition
1. Sole Proprietorship:
Advantage:
• Forming a sole proprietorship is very easy; there are no forms to file and no partners to
consult since the founder of the business is the sole owner.
Disadvantage :
• These organizations typically have limited access to the alternative sources of
financing. The owners of a sole proprietorship typically raise money by investing their
own funds, and by borrowing from a bank.
2. Partnership
Advantage :
• An important advantage of the partnership is that it provides access to equity,
or ownership, financing from multiple owners in return for partnership shares, or
units of ownership.
Disadvantage :
• Conflict on division of profits between partners.
3. Corporation.
Advantages :
• The shareholders’ liability is confined to the amount of their investment in the
company. In other words, if the corporation goes under, the owners can only
lose their investment.
• The life of the business is not tied to the life of the founding owners. For example, the
inventor Thomas Edison founded General Electric (GE) over a century ago. Edison died
in 1931, but the corporation lives on.
Disadvantage :
• Though management is expected to make ethical decisions that reflect the best interests
of the firm’s owners, this is not always the case. Indeed, managers often face situations
where their own personal interests differ from the interests of shareholders.
If you were to start a lawn mowing business for the summer, you’d probably form a sole
proprietorship. That is the simplest one to form – you don’t have to do anything. Moreover,
with a lawn mowing business the probability of a law suit is quite low, so the advantage of
limited liability is not particularly important.
1-6. The shareholders are the owners of the corporation. The management should run business
so as to maximize the shareholder wealth without being greedy for quick money generation
by unethical conducts and practices.
1-7. Shareholder wealth maximization isn’t the goal of every firm. Privately owned Newman’s
Own, the makers of salad dressing, spaghetti sauces, and other food products, was
established in 1982 with the goal of making money for educational and charitable purposes.
Paul Newman’s estate and the Newman’s Own Foundation donate all profits and royalties
after taxes for educational and charitable purposes.
Copyright © 2018 Pearson Education Ltd.
, 1-3 Titman/Keown/Martin • Financial Management, Thirteenth Edition, Global Edition
1-8. Extreme ethical lapses such as those evident in the Madoff Ponzi scheme may also break laws
and result in fines or imprisonment. In less extreme cases, deceptive accounting practices or
sales techniques once exposed lead to a loss of trust. Because individuals and firms are
reluctant to do business with those they mistrust, a reputation for unethical behavior over the
long run leads to adversarial relations with business partners, a loss of customers, and
destruction of the firm's value.
Copyright © 2018 Pearson Education Ltd.
,1-1 Titman/Keown/Martin • Financial Management, Thirteenth Edition, Global Edition
Chapter 1
Solutions to Study Questions
1-1. The solution to this problem is dependent upon the student’s experiences.
1-2. There are three basic types of issues that are addressed by the study of finance:
a. What long-term investments should the firm undertake? This area of finance is
generally referred to as capital budgeting.
b. How should the firm raise money to fund these investments? The firm’s funding
choices are generally referred to as capital structure decisions.
c. How can the firm best manage its cash flows as they arise in its day-to-day operations?
This area of finance is generally referred to as working capital management.
1-3. First, investors demand a minimum return for delaying consumption that must be greater
than the anticipated rate of inflation. If they didn’t receive enough to compensate for
anticipated inflation, investors would purchase whatever goods they desired ahead of time.
There isn’t much incentive to postpone consumption if your savings are going to decline in
terms of purchasing power.
Investment alternatives have different amounts of risk and expected returns. Investors
sometimes choose to put their money in risky investments because these investments offer
higher expected returns. The more risk an investment has, the higher will be its expected
return – that’s because risk investors don’t like risk, in particular, they don’t like the chance
that they might lose their money. That makes risky investments less attractive, which
means that to attract investors, riskier investments must be priced to offer investors a higher
expected rate of return. This relationship between risk and expected return is shown in
Figure 1.3.
Notice that we keep referring to expected return rather than actual return. We may have
expectations of what the returns for investing will be, but we can’t peer into the future and
see what those returns are actually going to be. Until after the fact, you are never sure what
the return on an investment will be. That is why General Motors bonds pay more interest
than U.S. Treasury bonds of the same maturity. The additional interest induces some
investors to take on the added risk of purchasing a General Motors bond.
1-4. Incremental cash flows describe the total cash effect on a company. This involves assessing
the difference between total cash flow to the company with the cash flow, and without the
cash flow. A company can then value these cash flows to see if it is worth more with the
project or without it.
1-5. The three business forms are:
1. Sole Proprietorship.
2. Partnership.
3. Corporation.
Copyright © 2018 Pearson Education Ltd.
,1-2 Titman/Keown/Martin • Financial Management, Thirteenth Edition, Global Edition
1. Sole Proprietorship:
Advantage:
• Forming a sole proprietorship is very easy; there are no forms to file and no partners to
consult since the founder of the business is the sole owner.
Disadvantage :
• These organizations typically have limited access to the alternative sources of
financing. The owners of a sole proprietorship typically raise money by investing their
own funds, and by borrowing from a bank.
2. Partnership
Advantage :
• An important advantage of the partnership is that it provides access to equity,
or ownership, financing from multiple owners in return for partnership shares, or
units of ownership.
Disadvantage :
• Conflict on division of profits between partners.
3. Corporation.
Advantages :
• The shareholders’ liability is confined to the amount of their investment in the
company. In other words, if the corporation goes under, the owners can only
lose their investment.
• The life of the business is not tied to the life of the founding owners. For example, the
inventor Thomas Edison founded General Electric (GE) over a century ago. Edison died
in 1931, but the corporation lives on.
Disadvantage :
• Though management is expected to make ethical decisions that reflect the best interests
of the firm’s owners, this is not always the case. Indeed, managers often face situations
where their own personal interests differ from the interests of shareholders.
If you were to start a lawn mowing business for the summer, you’d probably form a sole
proprietorship. That is the simplest one to form – you don’t have to do anything. Moreover,
with a lawn mowing business the probability of a law suit is quite low, so the advantage of
limited liability is not particularly important.
1-6. The shareholders are the owners of the corporation. The management should run business
so as to maximize the shareholder wealth without being greedy for quick money generation
by unethical conducts and practices.
1-7. Shareholder wealth maximization isn’t the goal of every firm. Privately owned Newman’s
Own, the makers of salad dressing, spaghetti sauces, and other food products, was
established in 1982 with the goal of making money for educational and charitable purposes.
Paul Newman’s estate and the Newman’s Own Foundation donate all profits and royalties
after taxes for educational and charitable purposes.
Copyright © 2018 Pearson Education Ltd.
, 1-3 Titman/Keown/Martin • Financial Management, Thirteenth Edition, Global Edition
1-8. Extreme ethical lapses such as those evident in the Madoff Ponzi scheme may also break laws
and result in fines or imprisonment. In less extreme cases, deceptive accounting practices or
sales techniques once exposed lead to a loss of trust. Because individuals and firms are
reluctant to do business with those they mistrust, a reputation for unethical behavior over the
long run leads to adversarial relations with business partners, a loss of customers, and
destruction of the firm's value.
Copyright © 2018 Pearson Education Ltd.
