,Solutions Manual (All
Chapters)
Fundamentals of Corporate Finance
(Australia) 8th edition Ross, Westerfield and
Jordan
Brad Jordan
Joe Smolira
© McGraw-Hill Australia
Ross, Fundamentals of Corporate Finance, 8e
,CHAPTER 1
INTRODUCTION TO CORPORATE
FINANCE
Answers to Concepts review and critical thinking questions
1. Capital budgeting (deciding whether to expand a manufacturing plant), capital structure
(deciding whether to issue new equity and use the proceeds to retire outstanding debt) and
working capital management (modifying the firm’s credit collection policy with its
customers).
2. Disadvantages: unlimited liability, limited life, difficulty in transferring ownership, difficulty
in raising capital funds. Some advantages: simpler, less regulation, the owners are also the
managers, sometimes personal tax rates are better than corporate tax rates.
3. The primary disadvantage of the corporate form is the double taxation to shareholders of
distributed earnings and dividends for some shareholders. Some advantages include: limited
liability, ease of transferability, ability to raise capital and unlimited life.
4. In response to stricter corporate governance legislations, some small firms have elected to go
dark because of the costs of compliance. The costs to comply with some of the corporate
governance legislations can be up to several million dollars, which can be a large percentage
of a small firm’s profits. A major cost of going dark is less access to capital. Since the firm is
no longer publicly traded, it can no longer raise money in the public market. Although the
company will still have access to bank loans and the private equity market, the costs associated
with raising funds in these markets are usually higher than the costs of raising funds in the
public market.
5. The treasurer’s office and the chief accountant’s office are the two primary organisational
groups that report directly to the chief financial officer. The chief accountant’s office handles
cost and financial accounting, tax management and management information systems. The
treasurer’s office is responsible for cash and credit management, capital budgeting and
financial planning. Therefore, the study of corporate finance is concentrated within the
treasury group’s functions.
6. The financial manager is the person responsible for making decisions in the interest of
shareholders of a firm. The financial manager of a firm should be motivated to make good
financial management decisions. The goal to maximise the current market value (share price)
of the equity of the firm (whether it is publicly traded or not) always motivates the actions of
the firm’s financial manager.
7. In the corporate form of ownership, the shareholders are the owners of the firm. The
shareholders elect the directors of the corporation, who in turn appoint the firm’s management.
© McGraw-Hill Australia
Ross, Fundamentals of Corporate Finance, 8e
, 2 SOLUTIONS MANUAL
This separation of ownership from control in the corporate form of organisation is what causes
agency problems to exist. Management may act in its own or someone else’s best interests,
rather than those of the shareholders. If such events occur, they may contradict the goal of
maximising the share price of the equity of the firm.
8. The Initial Public Offering (IPO) is a primary market transaction. The IPO is made to raise
capital by the issue of new securities and the primary market is the place where the new
securities are traded to raise capital. Hence, IPO is a primary market transaction.
9. In auction markets like the ASX, brokers buy and sell shares on the instructions of their clients,
placing orders on the ASX’s automated trading system. Dealer markets such as NASDAQ in
the US represent dealers operating in dispersed locales that buy and sell assets themselves.
They usually communicate with other dealers electronically or literally over the counter.
10. Since such organisations frequently pursue social or political missions, many different goals
are conceivable. One goal that is often cited is revenue minimisation; that is, provide whatever
goods and services are offered at the lowest possible cost to society. A better approach might
be to observe that even a not-for-profit business has equity. Thus, one answer is that the
appropriate goal is to maximise the value of the equity.
11. Presumably, the current shares’ value reflects the risk, timing and magnitude of all future cash
flows, both short-term and long-term. If this is correct, then the statement is false.
12. An argument can be made either way. At the one extreme, we could argue that in a market
economy, all of these things are priced. There implies an optimal level of, for example, ethical
and/or illegal behaviour, and the framework of share valuation explicitly includes these. At
the other extreme, we could argue that these are noneconomic phenomena and are best
handled through the political process. A classic (and highly relevant) thought question that
illustrates this debate: ‘A firm has estimated that the cost of improving the safety of one of its
products is $30 million. However, the firm believes that improving the safety of the product
will only save $20 million in product liability claims. What should the firm do?’
13. The goal of financial management is always to maximise the wealth of the shareholders. If
the financial management is assumed in a foreign country, the goal remains the same.
However, the best course of action towards that goal may require adjustments. This is due to
different social, political and economic climates, which differ country to country.
14. The goal of management should be to maximise the share price for the current shareholders.
If management believes that it can improve the profitability of the firm so that the share price
will exceed $35, then they should fight the offer from the outside company. If management
believes that this bidder or other unidentified bidders will actually pay more than $35 per
share to acquire the company, then they should still fight the offer. However, if the current
management cannot increase the value of the firm beyond the bid price, and no other higher
bids come in, then management is not acting in the interests of the shareholders by fighting
the offer. Since current managers often lose their jobs when the corporation is acquired, poorly
Chapters)
Fundamentals of Corporate Finance
(Australia) 8th edition Ross, Westerfield and
Jordan
Brad Jordan
Joe Smolira
© McGraw-Hill Australia
Ross, Fundamentals of Corporate Finance, 8e
,CHAPTER 1
INTRODUCTION TO CORPORATE
FINANCE
Answers to Concepts review and critical thinking questions
1. Capital budgeting (deciding whether to expand a manufacturing plant), capital structure
(deciding whether to issue new equity and use the proceeds to retire outstanding debt) and
working capital management (modifying the firm’s credit collection policy with its
customers).
2. Disadvantages: unlimited liability, limited life, difficulty in transferring ownership, difficulty
in raising capital funds. Some advantages: simpler, less regulation, the owners are also the
managers, sometimes personal tax rates are better than corporate tax rates.
3. The primary disadvantage of the corporate form is the double taxation to shareholders of
distributed earnings and dividends for some shareholders. Some advantages include: limited
liability, ease of transferability, ability to raise capital and unlimited life.
4. In response to stricter corporate governance legislations, some small firms have elected to go
dark because of the costs of compliance. The costs to comply with some of the corporate
governance legislations can be up to several million dollars, which can be a large percentage
of a small firm’s profits. A major cost of going dark is less access to capital. Since the firm is
no longer publicly traded, it can no longer raise money in the public market. Although the
company will still have access to bank loans and the private equity market, the costs associated
with raising funds in these markets are usually higher than the costs of raising funds in the
public market.
5. The treasurer’s office and the chief accountant’s office are the two primary organisational
groups that report directly to the chief financial officer. The chief accountant’s office handles
cost and financial accounting, tax management and management information systems. The
treasurer’s office is responsible for cash and credit management, capital budgeting and
financial planning. Therefore, the study of corporate finance is concentrated within the
treasury group’s functions.
6. The financial manager is the person responsible for making decisions in the interest of
shareholders of a firm. The financial manager of a firm should be motivated to make good
financial management decisions. The goal to maximise the current market value (share price)
of the equity of the firm (whether it is publicly traded or not) always motivates the actions of
the firm’s financial manager.
7. In the corporate form of ownership, the shareholders are the owners of the firm. The
shareholders elect the directors of the corporation, who in turn appoint the firm’s management.
© McGraw-Hill Australia
Ross, Fundamentals of Corporate Finance, 8e
, 2 SOLUTIONS MANUAL
This separation of ownership from control in the corporate form of organisation is what causes
agency problems to exist. Management may act in its own or someone else’s best interests,
rather than those of the shareholders. If such events occur, they may contradict the goal of
maximising the share price of the equity of the firm.
8. The Initial Public Offering (IPO) is a primary market transaction. The IPO is made to raise
capital by the issue of new securities and the primary market is the place where the new
securities are traded to raise capital. Hence, IPO is a primary market transaction.
9. In auction markets like the ASX, brokers buy and sell shares on the instructions of their clients,
placing orders on the ASX’s automated trading system. Dealer markets such as NASDAQ in
the US represent dealers operating in dispersed locales that buy and sell assets themselves.
They usually communicate with other dealers electronically or literally over the counter.
10. Since such organisations frequently pursue social or political missions, many different goals
are conceivable. One goal that is often cited is revenue minimisation; that is, provide whatever
goods and services are offered at the lowest possible cost to society. A better approach might
be to observe that even a not-for-profit business has equity. Thus, one answer is that the
appropriate goal is to maximise the value of the equity.
11. Presumably, the current shares’ value reflects the risk, timing and magnitude of all future cash
flows, both short-term and long-term. If this is correct, then the statement is false.
12. An argument can be made either way. At the one extreme, we could argue that in a market
economy, all of these things are priced. There implies an optimal level of, for example, ethical
and/or illegal behaviour, and the framework of share valuation explicitly includes these. At
the other extreme, we could argue that these are noneconomic phenomena and are best
handled through the political process. A classic (and highly relevant) thought question that
illustrates this debate: ‘A firm has estimated that the cost of improving the safety of one of its
products is $30 million. However, the firm believes that improving the safety of the product
will only save $20 million in product liability claims. What should the firm do?’
13. The goal of financial management is always to maximise the wealth of the shareholders. If
the financial management is assumed in a foreign country, the goal remains the same.
However, the best course of action towards that goal may require adjustments. This is due to
different social, political and economic climates, which differ country to country.
14. The goal of management should be to maximise the share price for the current shareholders.
If management believes that it can improve the profitability of the firm so that the share price
will exceed $35, then they should fight the offer from the outside company. If management
believes that this bidder or other unidentified bidders will actually pay more than $35 per
share to acquire the company, then they should still fight the offer. However, if the current
management cannot increase the value of the firm beyond the bid price, and no other higher
bids come in, then management is not acting in the interests of the shareholders by fighting
the offer. Since current managers often lose their jobs when the corporation is acquired, poorly
