Brealey 6CE
Solutions to Chapter 1
1. real
executive airplanes
brand names
financial
stocks
investment
capital budgeting
financing
2. A firm might cut its labour force dramatically which could reduce immediate expenses and
increase profits in the short term. Over the long term, however, the firm might not be able to
serve its customers properly or it might alienate its remaining workers; if so, future profits will
decrease, and the stock price will decrease in anticipation of these problems.
Similarly, a firm can boost profits over the short term by using less costly materials even if this
reduces the quality of the product. Once customers catch on, sales will decrease and profits
will fall in the future. The stock price will fall.
The moral of these examples is that, because stock prices reflect present and future profitability,
the firm should not necessarily sacrifice future prospects for short-term gains.
3. The key advantage of separating ownership and management in a large corporation is that it
gives the corporation permanence. The corporation continues to exist if managers are
replaced or if stockholders sell their ownership interests to other investors. The
corporation’s permanence is an essential characteristic in allowing corporations to obtain
the large amounts of financing required by many business entities.
, Both public and private corporations are distinct legal entities, separate from its owners (ie.,
its shareholders). The key difference between public and private corporations is the rules
governing the sale of their common shares. The common shares of a public corporation are
listed for trading on a stock exchange and investors can freely buy and sell the
corporation’s shares at the current stock price. The common shares of a private
corporations are not listed for trading on a stock exchange. Shareholders of private
corporations must negotiate directly with potential buyers and are subject to resale
restrictions.
You can learn to identify the risks associated with investing in private companies by going
to Ontario Securities Commission's website at:
http://www.osc.gov.on.ca/en/Investors_cbyi_index.htm
4. A sole proprietorship is easy to set up with a minimum of legal work. The business itself is not
taxed. For tax purposes, the income of the proprietorship is treated as the income of the
proprietor. The main disadvantages of a proprietorship are the proprietor’s unlimited liability
for the debts of the firm, and difficulty in raising large amounts of financing as the business
grows.
A partnership has the same tax advantage as the proprietorship. The partnership per se does not
pay taxes. The partnership files a tax return, but all of the partnership income is allocated to the
partners and treated as personal income. Also, it is fairly easy to set up a partnership. Because
there can be many partners, a partnership can raise capital more easily than a proprietorship.
However, like sole proprietors, partners have unlimited liability for the debts of the firm. In
fact, each partner has unlimited liability for all the business’s debts, not just his or her share.
Corporate organization has the advantage of limited liability. Its owners, the shareholders, are
not personally responsible for the debts of the corporation. It also allows for separation of
ownership and management, since shares in the firm can be traded without changing
management. A public corporation has the added advantage of easier access to equity
financing because its shares are traded in public stock markets. The major disadvantage of
corporate organization is the double taxation of income. Corporations pay taxes on their
income, and that income is taxed again when it is passed through to shareholders in the form of
dividends. Another disadvantage of corporate organization is the extra time and cost required
in order to manage a corporation’s legal affairs. These costs arise because the corporation must
be chartered and is considered a distinct legal entity. Such administrative costs are significant
only for small corporations, however. Furthermore, public corporations must provide investors
with detailed financial information in their annual reports and inform investors about significant
events. Disclosure takes time and resources and may also be costly in the sense that competitor
firms learn what is going on too.
, LLP’s may be considered to be hybrid organizations to the extent that while individual partners
have unlimited liability, they are not liable for the actions of their partners.
5. Double taxation means that a corporation’s income is taxed first at the corporate tax
rate, and then, when the income is distributed to shareholders as dividends, the
income is taxed again at the shareholder’s personal tax rate.
6. a, c, d.
7. On the website, www.td.com, the various businesses are listed in a table in the middle of
the page. Click a business, such as TD Canada Trust, and the main business activities
appear in a box under the table. To work as an investment banker, you would work for TD
Securities, listed under the heading “Wholesale Banking”. Clicking on “TD Securities”
and then on “Learn more” takes you to a webpage,
www.tdsecurities.com/tds/content/AU_AboutUs1?language=en_CA that says:
With more than 3,500 people in 15 12 offices around the world, TD Securities provides a
wide range of capital market products and services to corporate, government and
institutional clients who choose us for our knowledge, innovation and experience in the
following key areas of finance:
• Investment and Corporate Banking
• Capital Markets
• Interest Rate, Currency and Derivative Products
• Commodities
Our services include the underwriting and distribution of new debt and equity issues,
providing advice on strategic acquisitions and divestitures, and executing daily trading and
investment needs.With our history of delivering results, we’ve developed considerable
strengths, including recognized trading expertise and street-level market intelligence that
we use to consistently create value for our clients.
To trade securities, join TD Asset Management,
http://www.tdassetmanagement.com/Content/Homepage/p_Homepage.asp, “a highly
diversified North American investment management firm with leading market positions in
active, quantitative and passive portfolio management. The firm serves a large and
diversified client base including pension funds, corporations, institutions, endowments,
foundations and high net worth individuals. We also offer private money management
services and manage retail mutual funds.” To work as retail investment advisor, join TD
Waterhouse Private Client services, http://www.tdwaterhouse.ca/pcs/pia/index.jsp
8. a. Investment decision
, b. Financial asset
c. Public corporation
d. Corporation
e. Treasurer
f. The cost resulting from conflicts of interest between managers and shareholders Est
time: 01–05
Introduction to corporate finance
9. Financing decisions involve sources of capital used in the running of a firm. Investment
decisions, typically called capital budgeting, involve the uses of capital raised in the
financing process.
a. Investment decision
b. Financing decision
c. Investment decision
d. Investment decision
e. Investment decision
f. Financing decision: On the surface, this may appear similar to a dividend decision, but
in reality retiring debt is a change in capital structure and more closely aligned with a
financing decision.
10. a. Private corporation
b. Partnership
c. Public corporation
d. Public corporation
11. C. Ownership can be transferred without affecting operations and D. Managers can be
fired with no effect on ownership.
12. The individual stockholders of a corporation (i.e., the owners) are legally distinct from
the corporation itself, which is a separate legal entity. Consequently, the stockholders are
not personally liable for the debts of the corporation; the stockholders’ liability for the
Solutions to Chapter 1
1. real
executive airplanes
brand names
financial
stocks
investment
capital budgeting
financing
2. A firm might cut its labour force dramatically which could reduce immediate expenses and
increase profits in the short term. Over the long term, however, the firm might not be able to
serve its customers properly or it might alienate its remaining workers; if so, future profits will
decrease, and the stock price will decrease in anticipation of these problems.
Similarly, a firm can boost profits over the short term by using less costly materials even if this
reduces the quality of the product. Once customers catch on, sales will decrease and profits
will fall in the future. The stock price will fall.
The moral of these examples is that, because stock prices reflect present and future profitability,
the firm should not necessarily sacrifice future prospects for short-term gains.
3. The key advantage of separating ownership and management in a large corporation is that it
gives the corporation permanence. The corporation continues to exist if managers are
replaced or if stockholders sell their ownership interests to other investors. The
corporation’s permanence is an essential characteristic in allowing corporations to obtain
the large amounts of financing required by many business entities.
, Both public and private corporations are distinct legal entities, separate from its owners (ie.,
its shareholders). The key difference between public and private corporations is the rules
governing the sale of their common shares. The common shares of a public corporation are
listed for trading on a stock exchange and investors can freely buy and sell the
corporation’s shares at the current stock price. The common shares of a private
corporations are not listed for trading on a stock exchange. Shareholders of private
corporations must negotiate directly with potential buyers and are subject to resale
restrictions.
You can learn to identify the risks associated with investing in private companies by going
to Ontario Securities Commission's website at:
http://www.osc.gov.on.ca/en/Investors_cbyi_index.htm
4. A sole proprietorship is easy to set up with a minimum of legal work. The business itself is not
taxed. For tax purposes, the income of the proprietorship is treated as the income of the
proprietor. The main disadvantages of a proprietorship are the proprietor’s unlimited liability
for the debts of the firm, and difficulty in raising large amounts of financing as the business
grows.
A partnership has the same tax advantage as the proprietorship. The partnership per se does not
pay taxes. The partnership files a tax return, but all of the partnership income is allocated to the
partners and treated as personal income. Also, it is fairly easy to set up a partnership. Because
there can be many partners, a partnership can raise capital more easily than a proprietorship.
However, like sole proprietors, partners have unlimited liability for the debts of the firm. In
fact, each partner has unlimited liability for all the business’s debts, not just his or her share.
Corporate organization has the advantage of limited liability. Its owners, the shareholders, are
not personally responsible for the debts of the corporation. It also allows for separation of
ownership and management, since shares in the firm can be traded without changing
management. A public corporation has the added advantage of easier access to equity
financing because its shares are traded in public stock markets. The major disadvantage of
corporate organization is the double taxation of income. Corporations pay taxes on their
income, and that income is taxed again when it is passed through to shareholders in the form of
dividends. Another disadvantage of corporate organization is the extra time and cost required
in order to manage a corporation’s legal affairs. These costs arise because the corporation must
be chartered and is considered a distinct legal entity. Such administrative costs are significant
only for small corporations, however. Furthermore, public corporations must provide investors
with detailed financial information in their annual reports and inform investors about significant
events. Disclosure takes time and resources and may also be costly in the sense that competitor
firms learn what is going on too.
, LLP’s may be considered to be hybrid organizations to the extent that while individual partners
have unlimited liability, they are not liable for the actions of their partners.
5. Double taxation means that a corporation’s income is taxed first at the corporate tax
rate, and then, when the income is distributed to shareholders as dividends, the
income is taxed again at the shareholder’s personal tax rate.
6. a, c, d.
7. On the website, www.td.com, the various businesses are listed in a table in the middle of
the page. Click a business, such as TD Canada Trust, and the main business activities
appear in a box under the table. To work as an investment banker, you would work for TD
Securities, listed under the heading “Wholesale Banking”. Clicking on “TD Securities”
and then on “Learn more” takes you to a webpage,
www.tdsecurities.com/tds/content/AU_AboutUs1?language=en_CA that says:
With more than 3,500 people in 15 12 offices around the world, TD Securities provides a
wide range of capital market products and services to corporate, government and
institutional clients who choose us for our knowledge, innovation and experience in the
following key areas of finance:
• Investment and Corporate Banking
• Capital Markets
• Interest Rate, Currency and Derivative Products
• Commodities
Our services include the underwriting and distribution of new debt and equity issues,
providing advice on strategic acquisitions and divestitures, and executing daily trading and
investment needs.With our history of delivering results, we’ve developed considerable
strengths, including recognized trading expertise and street-level market intelligence that
we use to consistently create value for our clients.
To trade securities, join TD Asset Management,
http://www.tdassetmanagement.com/Content/Homepage/p_Homepage.asp, “a highly
diversified North American investment management firm with leading market positions in
active, quantitative and passive portfolio management. The firm serves a large and
diversified client base including pension funds, corporations, institutions, endowments,
foundations and high net worth individuals. We also offer private money management
services and manage retail mutual funds.” To work as retail investment advisor, join TD
Waterhouse Private Client services, http://www.tdwaterhouse.ca/pcs/pia/index.jsp
8. a. Investment decision
, b. Financial asset
c. Public corporation
d. Corporation
e. Treasurer
f. The cost resulting from conflicts of interest between managers and shareholders Est
time: 01–05
Introduction to corporate finance
9. Financing decisions involve sources of capital used in the running of a firm. Investment
decisions, typically called capital budgeting, involve the uses of capital raised in the
financing process.
a. Investment decision
b. Financing decision
c. Investment decision
d. Investment decision
e. Investment decision
f. Financing decision: On the surface, this may appear similar to a dividend decision, but
in reality retiring debt is a change in capital structure and more closely aligned with a
financing decision.
10. a. Private corporation
b. Partnership
c. Public corporation
d. Public corporation
11. C. Ownership can be transferred without affecting operations and D. Managers can be
fired with no effect on ownership.
12. The individual stockholders of a corporation (i.e., the owners) are legally distinct from
the corporation itself, which is a separate legal entity. Consequently, the stockholders are
not personally liable for the debts of the corporation; the stockholders’ liability for the
