Solutions Manual For Fundamentals Of Corporate Finance
6th Edition By Jonathan Berk, Peter Demarzo
,Contents
Chapter 1 The Corporation 1
Chapter 2 Introduction To Financial Statement Analysis 4
Chapter 3 Arbitrage And Financial Decision Making 16
Chapter 4 The Time Value Of Money 26
Chapter 5 Interest Rates 50
Chapter 6 Investment Decision Rules 69
Chapter 7 Fundamentals Of Capital Budgeting 89
Chapter 8 Valuing Bonds 106
Chapter 9 Valuing Stocks 123
Chapter 10 Capital Markets And The Pricing Of Risk 134
Chapter 11 Optimal Portfolio Choice And The Capital Asset Pricing Model 148
Chapter 12 Estimating The Cost Of Capital 166
Chapter 13 Investor Behavior And Capital Market Efficiency 175
Chapter 14 Capital Structure In A Perfect Market 184
Chapter 15 Debt And Taxes 193
Chapter 16 Financial Distress, Managerial Incentives, And Information 202
Chapter 17 Payout Policy 216
Chapter 18 Capital Budgeting And Valuation With Leverage 225
Chapter 19 Valuation And Financial Modeling: A Case Study 244
Chapter 20 Financial Options 253
Chapter 21 Option Valuation 263
Chapter 22 Real Options 274
Chapter 23 Raising Equity Capital 300
Chapter 24 Debt Financing 306
Chapter 25 Leasing 310
Chapter 26 Working Capital Management 317
Chapter 27 Short-Term Financial Planning 324
Chapter 28 Mergers And Acquisitions 331
Chapter 29 Corporate Governance 337
Chapter 30 Risk Management 340
Chapter 31 International Corporate Finance 352
,Chapter 1
The Corporation
1-1. What Is The Most Important Difference Between A Corporation And All Other Organization Forms?
A Corporation Is A Legal Entity Separate From Its Owners.
1-2. What Does The Phrase Limited Liability Mean In A Corporate Context?
Owners’ Liability Is Limited To The Amount They Invested In The Firm. Stockholders Are
Not Responsible For Any Encumbrances Of The Firm; In Particular, They Cannot Be Required
To Pay Back Any Debts Incurred By The Firm.
1-3. Which Organization Forms Give Their Owners Limited Liability?
Corporations And Limited Liability Companies Give Owners Limited Liability. Limited
Partnerships Provide Limited Liability For The Limited Partners, But Not For The General
Partners.
1-4. What Are The Main Advantages And Disadvantages Of Organizing A Firm As A Corporation?
Advantages: Limited Liability, Liquidity, Infinite Life
Disadvantages: Double Taxation, Separation Of Ownership And Control
1-5. Explain The Difference Between An S Corporation And A C Corporation.
C Corporations Much Pay Corporate Income Taxes; S Corporations Do Not Pay Corporate
Taxes But Must Pass Through The Income To Shareholders To Whom It Is Taxable. S
Corporations Are Also Limited To 75 Shareholders And Cannot Have Corporate Or Foreign
Stockholders.
1-6. You Are A Shareholder In A C Corporation. The Corporation Earns $2 Per Share Before
Taxes. Once It Has Paid Taxes It Will Distribute The Rest Of Its Earnings To You As A
Dividend. The Corporate Tax Rate Is 40% And The Personal Tax Rate On (Both Dividend
And Non-Dividend) Income Is 30%. How Much Is Left For You After All Taxes Are Paid?
First The Corporation Pays The Taxes. After Taxes, $2 (1 0.4) $1.20 Is Left To Pay
Dividends. Once The Dividend Is Paid, Personal Tax On This Must Be Paid, Which Leaves
$1.20 (1 0.3) $0.84 . So After All The Taxes Are Paid, You Are Left With 84¢.
1-7. Repeat Problem 6 Assuming The Corporation Is An S Corporation.
An S Corporation Does Not Pay Corporate Income Tax. So It Distributes $2 To Its
Stockholders. These Stockholders Must Then Pay Personal Income Tax On The
Distribution. So They Are Left With
$2 (1 0.3) $1.40 .
, 2
1-8. You Have Decided To Form A New Start-Up Company Developing Applications For
The Iphone. Give Examples Of The Three Distinct Types Of Financial Decisions You
Will Need To Make.
As The Manager Of An Iphone Applications Developer, You Will Make Three Types Of Financial Decisions.
i. You Will Make Investment Decisions Such As Determining Which Type Of Iphone
Application Projects Will Offer Your Company A Positive NPV And Therefore Your
Company Should Develop.
ii. You Will Make The Decision On How To Fund Your Iphone Application Investments And
What Mix Of Debt And Equity Your Company Will Have.
iii. You Will Be Responsible For The Cash Management Of Your Company, Ensuring That
Your Company Has The Necessary Funds To Make Investments, Pay Interest On
Loans, And Pay Your Employees.
1-9. Corporate Managers Work For The Owners Of The Corporation. Consequently, They
Should Make Decisions That Are In The Interests Of The Owners, Rather Than Their
Own. What Strategies Are Available To Shareholders To Help Ensure That Managers
Are Motivated To Act This Way?
Shareholders Can Do The Following.
i. Ensure That Employees Are Paid With Company Stock And/Or Stock Options.
ii. Ensure That Underperforming Managers Are Fired.
iii. Write Contracts That Ensure That The Interests Of The Managers And Shareholders Are Closely Aligned.
iv. Mount Hostile Takeovers.
1-10. Suppose You Are Considering Renting An Apartment. You, The Renter, Can Be Viewed
As An Agent While The Company That Owns The Apartment Can Be Viewed As The
Principal. What Principal-Agent Conflicts Do You Anticipate? Suppose, Instead, That
You Work For The Apartment Company. What Features Would You Put Into The Lease
Agreement That Would Give The Renter Incentives To Take Good Care Of The
Apartment?
The Agent (Renter) Will Not Take The Same Care Of The Apartment As The Principal
(Owner), Because The Renter Does Not Share In The Costs Of Fixing Damage To The
Apartment. To Mitigate This Problem, Having The Renter Pay A Deposit Should Motivate The
Renter To Keep Damages To A Minimum. The Deposit Forces The Renter To Share In The
Costs Of Fixing Any Problems That Are Caused By The Renter.
1-11. You Are The CEO Of A Company And You Are Considering Entering Into An Agreement
To Have Your Company Buy Another Company. You Think The Price Might Be Too
High, But You Will Be The CEO Of The Combined, Much Larger Company. You Know
That When The Company Gets Bigger, Your Pay And Prestige Will Increase. What Is
The Nature Of The Agency Conflict Here And How Is It Related To Ethical
Considerations?
There Is An Ethical Dilemma When The CEO Of A Firm Has Opposite Incentives To Those
Of The Shareholders. In This Case, You (As The CEO) Have An Incentive To Potentially
Overpay For Another Company (Which Would Be Damaging To Your Shareholders) Because
Your Pay And Prestige Will Improve.
1-12. Are Hostile Takeovers Necessarily Bad For Firms Or Their Investors? Explain.
No. They Are A Way To Discipline Managers Who Are Not Working In The Interests Of Shareholders.
1-13. What Is The Difference Between A Public And Private Corporation?
The Shares Of A Public Corporation Are Traded On An Exchange (Or "Over The Counter" In
An Electronic Trading System) While The Shares Of A Private Corporation Are Not Traded
On A Public Exchange.
1-14. Explain Why The Bid-Ask Spread Is A Transaction Cost.
Investors Always Buy At The Ask And Sell At The Bid. Since Ask Prices Always Exceed Bid
Prices, Investors “Lose” This Difference. It Is One Of The Costs Of Transacting. Since The
Market Makers Take The Other Side Of The Trade, They Make This Difference.
6th Edition By Jonathan Berk, Peter Demarzo
,Contents
Chapter 1 The Corporation 1
Chapter 2 Introduction To Financial Statement Analysis 4
Chapter 3 Arbitrage And Financial Decision Making 16
Chapter 4 The Time Value Of Money 26
Chapter 5 Interest Rates 50
Chapter 6 Investment Decision Rules 69
Chapter 7 Fundamentals Of Capital Budgeting 89
Chapter 8 Valuing Bonds 106
Chapter 9 Valuing Stocks 123
Chapter 10 Capital Markets And The Pricing Of Risk 134
Chapter 11 Optimal Portfolio Choice And The Capital Asset Pricing Model 148
Chapter 12 Estimating The Cost Of Capital 166
Chapter 13 Investor Behavior And Capital Market Efficiency 175
Chapter 14 Capital Structure In A Perfect Market 184
Chapter 15 Debt And Taxes 193
Chapter 16 Financial Distress, Managerial Incentives, And Information 202
Chapter 17 Payout Policy 216
Chapter 18 Capital Budgeting And Valuation With Leverage 225
Chapter 19 Valuation And Financial Modeling: A Case Study 244
Chapter 20 Financial Options 253
Chapter 21 Option Valuation 263
Chapter 22 Real Options 274
Chapter 23 Raising Equity Capital 300
Chapter 24 Debt Financing 306
Chapter 25 Leasing 310
Chapter 26 Working Capital Management 317
Chapter 27 Short-Term Financial Planning 324
Chapter 28 Mergers And Acquisitions 331
Chapter 29 Corporate Governance 337
Chapter 30 Risk Management 340
Chapter 31 International Corporate Finance 352
,Chapter 1
The Corporation
1-1. What Is The Most Important Difference Between A Corporation And All Other Organization Forms?
A Corporation Is A Legal Entity Separate From Its Owners.
1-2. What Does The Phrase Limited Liability Mean In A Corporate Context?
Owners’ Liability Is Limited To The Amount They Invested In The Firm. Stockholders Are
Not Responsible For Any Encumbrances Of The Firm; In Particular, They Cannot Be Required
To Pay Back Any Debts Incurred By The Firm.
1-3. Which Organization Forms Give Their Owners Limited Liability?
Corporations And Limited Liability Companies Give Owners Limited Liability. Limited
Partnerships Provide Limited Liability For The Limited Partners, But Not For The General
Partners.
1-4. What Are The Main Advantages And Disadvantages Of Organizing A Firm As A Corporation?
Advantages: Limited Liability, Liquidity, Infinite Life
Disadvantages: Double Taxation, Separation Of Ownership And Control
1-5. Explain The Difference Between An S Corporation And A C Corporation.
C Corporations Much Pay Corporate Income Taxes; S Corporations Do Not Pay Corporate
Taxes But Must Pass Through The Income To Shareholders To Whom It Is Taxable. S
Corporations Are Also Limited To 75 Shareholders And Cannot Have Corporate Or Foreign
Stockholders.
1-6. You Are A Shareholder In A C Corporation. The Corporation Earns $2 Per Share Before
Taxes. Once It Has Paid Taxes It Will Distribute The Rest Of Its Earnings To You As A
Dividend. The Corporate Tax Rate Is 40% And The Personal Tax Rate On (Both Dividend
And Non-Dividend) Income Is 30%. How Much Is Left For You After All Taxes Are Paid?
First The Corporation Pays The Taxes. After Taxes, $2 (1 0.4) $1.20 Is Left To Pay
Dividends. Once The Dividend Is Paid, Personal Tax On This Must Be Paid, Which Leaves
$1.20 (1 0.3) $0.84 . So After All The Taxes Are Paid, You Are Left With 84¢.
1-7. Repeat Problem 6 Assuming The Corporation Is An S Corporation.
An S Corporation Does Not Pay Corporate Income Tax. So It Distributes $2 To Its
Stockholders. These Stockholders Must Then Pay Personal Income Tax On The
Distribution. So They Are Left With
$2 (1 0.3) $1.40 .
, 2
1-8. You Have Decided To Form A New Start-Up Company Developing Applications For
The Iphone. Give Examples Of The Three Distinct Types Of Financial Decisions You
Will Need To Make.
As The Manager Of An Iphone Applications Developer, You Will Make Three Types Of Financial Decisions.
i. You Will Make Investment Decisions Such As Determining Which Type Of Iphone
Application Projects Will Offer Your Company A Positive NPV And Therefore Your
Company Should Develop.
ii. You Will Make The Decision On How To Fund Your Iphone Application Investments And
What Mix Of Debt And Equity Your Company Will Have.
iii. You Will Be Responsible For The Cash Management Of Your Company, Ensuring That
Your Company Has The Necessary Funds To Make Investments, Pay Interest On
Loans, And Pay Your Employees.
1-9. Corporate Managers Work For The Owners Of The Corporation. Consequently, They
Should Make Decisions That Are In The Interests Of The Owners, Rather Than Their
Own. What Strategies Are Available To Shareholders To Help Ensure That Managers
Are Motivated To Act This Way?
Shareholders Can Do The Following.
i. Ensure That Employees Are Paid With Company Stock And/Or Stock Options.
ii. Ensure That Underperforming Managers Are Fired.
iii. Write Contracts That Ensure That The Interests Of The Managers And Shareholders Are Closely Aligned.
iv. Mount Hostile Takeovers.
1-10. Suppose You Are Considering Renting An Apartment. You, The Renter, Can Be Viewed
As An Agent While The Company That Owns The Apartment Can Be Viewed As The
Principal. What Principal-Agent Conflicts Do You Anticipate? Suppose, Instead, That
You Work For The Apartment Company. What Features Would You Put Into The Lease
Agreement That Would Give The Renter Incentives To Take Good Care Of The
Apartment?
The Agent (Renter) Will Not Take The Same Care Of The Apartment As The Principal
(Owner), Because The Renter Does Not Share In The Costs Of Fixing Damage To The
Apartment. To Mitigate This Problem, Having The Renter Pay A Deposit Should Motivate The
Renter To Keep Damages To A Minimum. The Deposit Forces The Renter To Share In The
Costs Of Fixing Any Problems That Are Caused By The Renter.
1-11. You Are The CEO Of A Company And You Are Considering Entering Into An Agreement
To Have Your Company Buy Another Company. You Think The Price Might Be Too
High, But You Will Be The CEO Of The Combined, Much Larger Company. You Know
That When The Company Gets Bigger, Your Pay And Prestige Will Increase. What Is
The Nature Of The Agency Conflict Here And How Is It Related To Ethical
Considerations?
There Is An Ethical Dilemma When The CEO Of A Firm Has Opposite Incentives To Those
Of The Shareholders. In This Case, You (As The CEO) Have An Incentive To Potentially
Overpay For Another Company (Which Would Be Damaging To Your Shareholders) Because
Your Pay And Prestige Will Improve.
1-12. Are Hostile Takeovers Necessarily Bad For Firms Or Their Investors? Explain.
No. They Are A Way To Discipline Managers Who Are Not Working In The Interests Of Shareholders.
1-13. What Is The Difference Between A Public And Private Corporation?
The Shares Of A Public Corporation Are Traded On An Exchange (Or "Over The Counter" In
An Electronic Trading System) While The Shares Of A Private Corporation Are Not Traded
On A Public Exchange.
1-14. Explain Why The Bid-Ask Spread Is A Transaction Cost.
Investors Always Buy At The Ask And Sell At The Bid. Since Ask Prices Always Exceed Bid
Prices, Investors “Lose” This Difference. It Is One Of The Costs Of Transacting. Since The
Market Makers Take The Other Side Of The Trade, They Make This Difference.
