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CHAPTER 1
Introduction to Corporate Finance
The values shown in the solutions may be rounded for display purposes. However, the answers were derived
using a spreadsheet without any intermediate rounding.
Answers to Problem Sets
1. a. real
b. executive airplanes
c. brand names
d. financial
e. bonds
*f. investment or capital expenditure
*g. capital budgeting or investment
h. financing
*Note that f and g are interchangeable in the question.
Est time: 01-05
2. A trademark, a factory, undeveloped land, and your work force (c, d, e, and g) are all real assets.
Real assets are identifiable as items with intrinsic value. The others in the list are financial assets,
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that is, these assets derive value because of a contractual claim.
Est time: 01-05
3. a. Financial assets, such as stocks or bank loans, are claims held by investors. Corporations
sell financial assets to raise the cash to invest in real assets such as plant and equipment.
Some real assets are intangible.
b. Capital expenditure means investment in real assets. Financing means raising the cash for
this investment.
c. The shares of public corporations are traded on stock exchanges and can be purchased by
a wide range of investors. The shares of closely held corporations are not publicly traded
and are held by a small group of private investors.
d. Unlimited liability: Investors are responsible for all the firm‘s debts. A sole proprietor has
unlimited liability. Investors in corporations have limited liability. They can lose their
investment, but no more.
Est time: 01-05
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4. Items c and d apply to corporations. Because corporations have perpetual life, ownership can be
transferred without affecting operations, and managers can be fired with no effect on ownership.
Other forms of business may have unlimited liability and limited life.
Est time: 01-05
5. Separation of ownership facilitates the key attributes of a corporation, including limited liability for
investors, transferability of ownership, a separate legal personality of the corporation, and
delegated centralized management. These four attributes provide substantial benefit for investors,
including the ability to diversify their investment among many uncorrelated returns—a very
valuable tool explored in later chapters. Also, these attributes allow investors to quickly exit, enter,
or short sell an investment, thereby generating an active liquid market for corporations.
However, these positive aspects also introduce substantial negative externalities as well. The
separation of ownership from management typically leads to agency problems, where managers
prefer to consume private perks or make other decisions for their private benefit—rather than
maximize shareholder wealth. Shareholders tend to exercise less oversight of each individual
investment as their diversification increases. Finally, the corporation‘s separate legal personality
makes it difficult to enforce accountability if they externalize costs onto society.
Est time: 01-05
6. Shareholders will only vote to maximize shareholder wealth. Shareholders can modify their
pattern of consumption through borrowing and lending, match risk preferences, and hopefully
balance their own checkbooks (or hire a qualified professional to help them with these tasks).
Est time: 01-05
7. If the investment increases the firm‘s wealth, it increases the firm‘s share value. Ms. Espinoza
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CHAPTER 1
Introduction to Corporate Finance
The values shown in the solutions may be rounded for display purposes. However, the answers were derived
using a spreadsheet without any intermediate rounding.
Answers to Problem Sets
1. a. real
b. executive airplanes
c. brand names
d. financial
e. bonds
*f. investment or capital expenditure
*g. capital budgeting or investment
h. financing
*Note that f and g are interchangeable in the question.
Est time: 01-05
2. A trademark, a factory, undeveloped land, and your work force (c, d, e, and g) are all real assets.
Real assets are identifiable as items with intrinsic value. The others in the list are financial assets,
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Distribution of this document is illegal extra per year?
, Stuvia.com - The Marketplace to Buy and Sell your Study Material
that is, these assets derive value because of a contractual claim.
Est time: 01-05
3. a. Financial assets, such as stocks or bank loans, are claims held by investors. Corporations
sell financial assets to raise the cash to invest in real assets such as plant and equipment.
Some real assets are intangible.
b. Capital expenditure means investment in real assets. Financing means raising the cash for
this investment.
c. The shares of public corporations are traded on stock exchanges and can be purchased by
a wide range of investors. The shares of closely held corporations are not publicly traded
and are held by a small group of private investors.
d. Unlimited liability: Investors are responsible for all the firm‘s debts. A sole proprietor has
unlimited liability. Investors in corporations have limited liability. They can lose their
investment, but no more.
Est time: 01-05
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Distribution of this document is illegal extra per year?
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4. Items c and d apply to corporations. Because corporations have perpetual life, ownership can be
transferred without affecting operations, and managers can be fired with no effect on ownership.
Other forms of business may have unlimited liability and limited life.
Est time: 01-05
5. Separation of ownership facilitates the key attributes of a corporation, including limited liability for
investors, transferability of ownership, a separate legal personality of the corporation, and
delegated centralized management. These four attributes provide substantial benefit for investors,
including the ability to diversify their investment among many uncorrelated returns—a very
valuable tool explored in later chapters. Also, these attributes allow investors to quickly exit, enter,
or short sell an investment, thereby generating an active liquid market for corporations.
However, these positive aspects also introduce substantial negative externalities as well. The
separation of ownership from management typically leads to agency problems, where managers
prefer to consume private perks or make other decisions for their private benefit—rather than
maximize shareholder wealth. Shareholders tend to exercise less oversight of each individual
investment as their diversification increases. Finally, the corporation‘s separate legal personality
makes it difficult to enforce accountability if they externalize costs onto society.
Est time: 01-05
6. Shareholders will only vote to maximize shareholder wealth. Shareholders can modify their
pattern of consumption through borrowing and lending, match risk preferences, and hopefully
balance their own checkbooks (or hire a qualified professional to help them with these tasks).
Est time: 01-05
7. If the investment increases the firm‘s wealth, it increases the firm‘s share value. Ms. Espinoza
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