Solution Manual For
Foundations of Finance, Global Edition, 10th edition
Chapters 1-17
CHAPTER 1
This chapter lays a foundation for what will follow. First, it focuses on the goal of the firm,
followed by the five principles that form the foundations of financial management and the role of
finance in business. The chapter then reviews the legal forms of business organization and
discusses the tax implications relating to financial decisions. Finally, the chapter discusses the
multinational firm and its role in finance.
CHAPTER OUTLINE
I. The Goal of the Firm
A. In this book, we will designate maximization of shareholder wealth to be the goal of the
firm, by which we mean maximization of the total market value of the firm’s common
stock.
B. We have chosen the goal of shareholder wealth maximization because the effects of all
financial decisions are included in this goal.
C. In order to employ this goal, we need not consider every price change to be a market
interpretation of the worth of our decisions. What we do focus on is the effect that our
decision should have on the stock price if everything were held constant.
II. Five Principles That Form the Foundations of Finance
A. Principle 1: Cash Flow Is What Matters. In measuring value, we will use cash flows
rather than accounting profits because it is only cash flows that the firm receives and is
able to reinvest. In addition, in making business decisions, we will concern ourselves
with only what happens as a result of that decision.
B. Principle 2: Money Has a Time Value. Almost all financial decisions involve
comparing money in different periods, perhaps investing today and receiving returns
later, or borrowing money today and paying it off later. A dollar received today is worth
more than a dollar received in the future because of the time value of money.
C. Principle 3: Risk Requires a Reward. There is a risk-return trade-off in finance—
typical risk-averse investors won’t take additional risk unless they expect to be
compensated with additional return. Almost all financial decisions involve some sort of
risk-return trade-off.
D. Principle 4: Market Prices Are Generally Right. In general, financial markets are
quick to impound new information into stock prices, and the prices tend to be correct.
, E. Principle 5: Conflicts of Interest Cause Agency Problems. Self-interested managers
will not work for the owners’ best interest unless it is in the managers’ best interest as
well. The corporate agency problem is a result of the separation of ownership from the
decision makers of the firm. As a result, managers may make decisions that are not in line
with the goal of maximization of shareholder wealth.
F. The Essential Elements of Ethics and Trust. Ethical behavior is doing the right thing,
and ethical dilemmas are everywhere in finance. Ethical behavior is important in
financial management, just as it is important in everything we do. Businesses cannot
interact unless they trust each other. Unfortunately, precisely how we define what is and
is not ethical behavior is sometimes difficult. Nevertheless, we should not give up the
quest.
III. The Role of Finance in Business
A. Three basic types of issues are addressed by the study of finance.
1. What long-term investments should the firm undertake? This area of finance is
generally referred to as capital budgeting.
2. How should the firm raise money to fund these investments? The firm’s funding
choices are generally referred to as capital structure decisions.
3. 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.
B. Why Study Finance?
Every area of business involves making choices that relate to the management of money
over time. A basic knowledge of finance is necessary even for nonfinance majors. An
understanding of finance is also important for management of personal finances.
C. The Role of the Financial Manager
Firms have many different organizational structures. Financial officers may fill any of the
following roles: vice president for finance, chief financial officer (CFO), treasurer, or
controller.
IV. The Legal Forms of Business Organization
A. Sole Proprietorships
1. Sole proprietorship: A business owned by a single individual, which has a minimum
amount of legal structure
2. The predominant form of business organization in the United States in total numbers
is the sole proprietorship.
3. There are several advantages of sole proprietorships.
a. They are easily established with few complications.
b. There are minimal organizational costs.
c. The owner does not have to share profits or control with others.
, 4. There are some disadvantages of sole proprietorships.
a. The owner has unlimited liability.
b. The owner must absorb all losses.
c. Equity capital is limited to the owner’s personal investment.
d. The business terminates immediately upon the owner’s death.
B. Partnerships
1. Partnership: An association of two or more individuals coming together as co-
owners to operate a business for profit
2. Partnerships come in two types.
a. General partnership: This is a partnership in which all partners are fully liable for
the indebtedness incurred by the partnership. The relationship between partners is
dictated by the partnership agreement.
(l) General partnerships have some advantages.
(a) The organizational requirements are minimal.
(b) The government regulations are negligible.
(2) General partnerships have some disadvantages.
(a) All partners have unlimited liability.
(b) It can be difficult to raise large amounts of capital.
(c) The partnership is dissolved by the death or withdrawal of the general
partner.
b. Limited partnership: This is a partnership in which one or more of the partners has
limited liability, restricted to the amount of capital he or she invests in the
partnership.
(l) Limited partnerships have some advantages.
(a) For the limited partners, liability is limited to the amount of capital
invested in the company.
(b) The withdrawal or death of a limited partner does not affect the
continuity of the business.
(c) Limited partners have a stronger incentive to invest, improving the
partnership’s ability to raise capital.
(2) Limited partnerships have some disadvantages.
(a) At least one general partner must have unlimited liability in the
partnership.
(b) The names of the limited partners may not appear in the name of the
firm.
, (c) The limited partners may not participate in the management of the
business.
(d) It is more expensive to organize than a general partnership because a
written agreement is mandatory.
C. Corporations
1. Corporation: An ―impersonal‖ legal entity having the power to purchase, sell, and
own assets and to incur liabilities while existing separately and apart from its owners
2. Ownership of a corporation is evidenced by shares of stock.
3. The corporate form of organization has several advantages.
a. The owners have limited liability.
b. Transferability of ownership is relatively easy through the sale of one’s shares of
stock.
c. The death of an owner does not result in the discontinuance of the firm.
d. The ability to raise large amounts of capital is increased.
4. The corporate form of organization has some disadvantages.
a. It is the most difficult and expensive form of business to establish.
b. Control of the corporation is not guaranteed by partial ownership of stock.
c. Corporations also suffer from a double taxation of dividends. The firm first pays
taxes on the income it earns; after paying taxes on this income, the income is paid
to investors in the form of dividends. The investor then pays personal taxes on
that dividend income.
D. Organizational Form and Taxes: The Double Taxation on Dividends and Pass-Through
Entities
E. S-Corporations and Limited Liability Companies (LLC)
1. The S-corporation provides limited liability while allowing the business owners to be
taxed as if they were a partnership—that is, distributions back to the owners are not
taxed twice as is the case with dividends paid by corporations.
2. The limited liability company (LLC) is a cross between a partnership and a
corporation. The LLC retains limited liability for its owners but is run and taxed like a
partnership.
F. Which Organizational Form Should Be Chosen?
V. Finance and the Multinational Firm: The New Role
VI. Developing Skills for Your Career
A. Critical Thinking Skills
B. Excel Skills
C. Data Analysis Skills
Foundations of Finance, Global Edition, 10th edition
Chapters 1-17
CHAPTER 1
This chapter lays a foundation for what will follow. First, it focuses on the goal of the firm,
followed by the five principles that form the foundations of financial management and the role of
finance in business. The chapter then reviews the legal forms of business organization and
discusses the tax implications relating to financial decisions. Finally, the chapter discusses the
multinational firm and its role in finance.
CHAPTER OUTLINE
I. The Goal of the Firm
A. In this book, we will designate maximization of shareholder wealth to be the goal of the
firm, by which we mean maximization of the total market value of the firm’s common
stock.
B. We have chosen the goal of shareholder wealth maximization because the effects of all
financial decisions are included in this goal.
C. In order to employ this goal, we need not consider every price change to be a market
interpretation of the worth of our decisions. What we do focus on is the effect that our
decision should have on the stock price if everything were held constant.
II. Five Principles That Form the Foundations of Finance
A. Principle 1: Cash Flow Is What Matters. In measuring value, we will use cash flows
rather than accounting profits because it is only cash flows that the firm receives and is
able to reinvest. In addition, in making business decisions, we will concern ourselves
with only what happens as a result of that decision.
B. Principle 2: Money Has a Time Value. Almost all financial decisions involve
comparing money in different periods, perhaps investing today and receiving returns
later, or borrowing money today and paying it off later. A dollar received today is worth
more than a dollar received in the future because of the time value of money.
C. Principle 3: Risk Requires a Reward. There is a risk-return trade-off in finance—
typical risk-averse investors won’t take additional risk unless they expect to be
compensated with additional return. Almost all financial decisions involve some sort of
risk-return trade-off.
D. Principle 4: Market Prices Are Generally Right. In general, financial markets are
quick to impound new information into stock prices, and the prices tend to be correct.
, E. Principle 5: Conflicts of Interest Cause Agency Problems. Self-interested managers
will not work for the owners’ best interest unless it is in the managers’ best interest as
well. The corporate agency problem is a result of the separation of ownership from the
decision makers of the firm. As a result, managers may make decisions that are not in line
with the goal of maximization of shareholder wealth.
F. The Essential Elements of Ethics and Trust. Ethical behavior is doing the right thing,
and ethical dilemmas are everywhere in finance. Ethical behavior is important in
financial management, just as it is important in everything we do. Businesses cannot
interact unless they trust each other. Unfortunately, precisely how we define what is and
is not ethical behavior is sometimes difficult. Nevertheless, we should not give up the
quest.
III. The Role of Finance in Business
A. Three basic types of issues are addressed by the study of finance.
1. What long-term investments should the firm undertake? This area of finance is
generally referred to as capital budgeting.
2. How should the firm raise money to fund these investments? The firm’s funding
choices are generally referred to as capital structure decisions.
3. 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.
B. Why Study Finance?
Every area of business involves making choices that relate to the management of money
over time. A basic knowledge of finance is necessary even for nonfinance majors. An
understanding of finance is also important for management of personal finances.
C. The Role of the Financial Manager
Firms have many different organizational structures. Financial officers may fill any of the
following roles: vice president for finance, chief financial officer (CFO), treasurer, or
controller.
IV. The Legal Forms of Business Organization
A. Sole Proprietorships
1. Sole proprietorship: A business owned by a single individual, which has a minimum
amount of legal structure
2. The predominant form of business organization in the United States in total numbers
is the sole proprietorship.
3. There are several advantages of sole proprietorships.
a. They are easily established with few complications.
b. There are minimal organizational costs.
c. The owner does not have to share profits or control with others.
, 4. There are some disadvantages of sole proprietorships.
a. The owner has unlimited liability.
b. The owner must absorb all losses.
c. Equity capital is limited to the owner’s personal investment.
d. The business terminates immediately upon the owner’s death.
B. Partnerships
1. Partnership: An association of two or more individuals coming together as co-
owners to operate a business for profit
2. Partnerships come in two types.
a. General partnership: This is a partnership in which all partners are fully liable for
the indebtedness incurred by the partnership. The relationship between partners is
dictated by the partnership agreement.
(l) General partnerships have some advantages.
(a) The organizational requirements are minimal.
(b) The government regulations are negligible.
(2) General partnerships have some disadvantages.
(a) All partners have unlimited liability.
(b) It can be difficult to raise large amounts of capital.
(c) The partnership is dissolved by the death or withdrawal of the general
partner.
b. Limited partnership: This is a partnership in which one or more of the partners has
limited liability, restricted to the amount of capital he or she invests in the
partnership.
(l) Limited partnerships have some advantages.
(a) For the limited partners, liability is limited to the amount of capital
invested in the company.
(b) The withdrawal or death of a limited partner does not affect the
continuity of the business.
(c) Limited partners have a stronger incentive to invest, improving the
partnership’s ability to raise capital.
(2) Limited partnerships have some disadvantages.
(a) At least one general partner must have unlimited liability in the
partnership.
(b) The names of the limited partners may not appear in the name of the
firm.
, (c) The limited partners may not participate in the management of the
business.
(d) It is more expensive to organize than a general partnership because a
written agreement is mandatory.
C. Corporations
1. Corporation: An ―impersonal‖ legal entity having the power to purchase, sell, and
own assets and to incur liabilities while existing separately and apart from its owners
2. Ownership of a corporation is evidenced by shares of stock.
3. The corporate form of organization has several advantages.
a. The owners have limited liability.
b. Transferability of ownership is relatively easy through the sale of one’s shares of
stock.
c. The death of an owner does not result in the discontinuance of the firm.
d. The ability to raise large amounts of capital is increased.
4. The corporate form of organization has some disadvantages.
a. It is the most difficult and expensive form of business to establish.
b. Control of the corporation is not guaranteed by partial ownership of stock.
c. Corporations also suffer from a double taxation of dividends. The firm first pays
taxes on the income it earns; after paying taxes on this income, the income is paid
to investors in the form of dividends. The investor then pays personal taxes on
that dividend income.
D. Organizational Form and Taxes: The Double Taxation on Dividends and Pass-Through
Entities
E. S-Corporations and Limited Liability Companies (LLC)
1. The S-corporation provides limited liability while allowing the business owners to be
taxed as if they were a partnership—that is, distributions back to the owners are not
taxed twice as is the case with dividends paid by corporations.
2. The limited liability company (LLC) is a cross between a partnership and a
corporation. The LLC retains limited liability for its owners but is run and taxed like a
partnership.
F. Which Organizational Form Should Be Chosen?
V. Finance and the Multinational Firm: The New Role
VI. Developing Skills for Your Career
A. Critical Thinking Skills
B. Excel Skills
C. Data Analysis Skills
