CFIN4 - CHAPTER 1
INTEGRATIVE PROBLEM SOLUTIONS
a. Finance deals with decisions about money—that is, how money is raised and used by
companies and individuals. Because value is based on cash flows, finance is integral to
the successful operations of a firm. To be successful, a firm needs to understand how to
raise funds, how much it costs to use investors’ money, and how to appropriately invest
funds.
b. Everyone deals with financial decisions, both in business and in their personal lives. For
this reason, and because there are financial implications in nearly every business-related
decision, it is important that everyone has at least a general knowledge of financial
concepts so that they can make informed decisions about money. Marty should be
especially knowledgeable in finance, because he is a one-person operation—he is the
person who makes the financial decisions for his firm.
c. The three main forms of business organization are the proprietorship, the partnership, and
the corporation. Although proprietorships and partnerships are easy to start, the major
disadvantage to these forms of business is that the owners have unlimited personal liability
for the debts of the businesses. On the other hand, a corporation is more difficult to start
than the other forms of business, but owners have limited liability. Most business is
conducted by corporations because this organizational form maximizes firms’ values.
d. Mr. Kimble probably should organize as a proprietorship, because it is easy to start the
business as a proprietorship and it generally is more advantageous from a tax standpoint
for a small business to be organized as a proprietorship rather than as a corporation.
e. If the company is so successful that it grows to be a large organization, then Mr. Kimble
probably should change from a proprietorship to a corporation. A major reason for
changing to a corporation is to protect personal wealth—the owners of a corporation are
not personally liable for the debts of the business, whereas the owners of proprietorships
and partnerships are personally fully liable for all business debts. When a company
becomes very large, most owners believe that the limited liability offered by the corporate
form of business is extremely important.
f. Mr. Kimble should operate the business so that his best interests are met. Perhaps he
would like to maximize the value of his company, or perhaps he would prefer to maximize
his leisure time while making a good living with his business. Whatever goal(s) he
chooses, as long as he is sole owner of the company, Mr. Kimble can operate the business
, as he pleases. However, if he sells a portion of the company to investors, then Mr. Kimble
will have to pay more attention to the best interests of the investors—that is, he will have to
pursue the goal of maximizing the value of the firm.
g. After converting to a corporation and selling stock to outsiders, PAR will have multiple
owners, which means that Mr. Kimble and his management team will have to consider the
best interests of the other owners when making decisions about the corporation. Mr.
Kimble and his management team are “agents” of the stockholders, and they should
operate the business so as to maximize the value of the firm. To ensure that management
makes decisions that are in the best interests of the owners, the company can pay
incentives that are based on the success of the firm, make management owners of the
firms, or use other methods to encourage management to make the “correct” decisions.
Such methods will help to lessen the chances of management making decisions in their
own best interests rather than the stockholders’ best interests—that is, the chances of
agency problems will be mitigated.
h. U.S. and foreign companies “go international” for the following major reasons:
1. To seek new markets. After a company has saturated its home market, growth
opportunities often are better in foreign markets.
2. To seek raw materials.
3. To seek new technology. No single nation holds a commanding advantage in all
technologies, so companies scour the globe for leading scientific and design ideas.
4. To seek production efficiency. Companies in countries where production costs are high
tend to shift production to low-cost countries.
5. To avoid political and regulatory hurdles. For example, companies move production to
foreign countries in which they sell products to get around U.S. import quotas.
i. 1. Different currency denominations. Cash flows in various parts of a multinational
corporate system often are denominated in different currencies. Hence, an analysis of
exchange rates and the effects of fluctuating currency values must be included in all
financial analyses.
2. Economic and legal ramifications. Each country in which the firm operates has its own
unique political and economic institutions, and institutional differences among countries
can cause significant problems when a firm tries to coordinate and control the
worldwide operations of its subsidiaries. Such differences can restrict multinational
corporations’ flexibility to deploy resources as they wish and can even make
procedures illegal in one part of the company that are required in another part. These
differences also make it difficult for executives trained in one country to operate
effectively in another.
,3. Language differences. The ability to communicate is critical in all business
transactions.
4. Cultural differences. Even within geographic regions long considered fairly
homogeneous, different countries have unique cultural heritages that shape values and
influence the role of business in the society. Multinational corporations find that such
matters as defining the appropriate goals of the firm, attitudes toward risk taking,
dealing with employees, and the ability to curtail unprofitable operations can vary
dramatically from one country to the next.
5. Role of governments. Most traditional models in finance assume the existence of a
competitive marketplace in which the terms of trade are determined by the participants.
However, in foreign countries, in some instances, the terms under which companies
compete, the actions that must be taken or avoided, and the terms of trade on various
transactions are determined not in the marketplace but by direct negotiation between
the host government and the multinational corporation.
6. Political risk. The distinguishing characteristic that differentiates a nation from a
multinational corporation is that the nation exercises sovereignty over the people and
property in its territory. Hence, a nation is free to place constraints on the transfer of
corporate resources and even to expropriate—that is, take for public use—the assets
of a firm without compensation.
, CFIN4 - CHAPTER 2
INTEGRATIVE PROBLEM SOLUTION
a. Begin by reviewing briefly what balance sheets and income statements are. Then give an
overview of the statement of cash flows. Explain that some data (net income, depreciation,
and dividends) come from the income statement, while the other items reflect differences
between balance sheet accounts and thus show changes in those accounts between the
two dates.
The cash flow statement highlights some important aspects of Computron’s financial condition.
First, note that the firm’s net operating cash flow is -$73,780, so its operations are draining cash
despite the positive net income reported on the income statement. Second, because of its negative
cash flow from operations, Computron had to borrow a total of $126,180 in long- and short-term
debt to cover its operating cash outlays, to pay for fixed asset additions, and to pay dividends. Even
after all this borrowing, Computron’s cash account still fell by $5,600 during 2010.
b. Financial ratios are used to get an idea about how well the company is being operated,
and where it needs improving. The ratio categories, and their purposes, are as follows:
1. Liquidity: Can the company make required payments in the short run (defined as the
next year)?
2. Asset management: Are the investments in assets about right in view of sales levels?
3. Debt management (financing mix): Does the company have about the right amount of
debt, or is it over leveraged?
4. Profitability: Are costs under good control as reflected in the profit margin, ROE, and
ROE?
5. Market values: Do investors like what they see as reflected in the P/E and M/B ratios?
c. Computron has $540,200 in obligations that must be satisfied within the coming year. Will
it have trouble meeting its required payments? A full liquidity analysis requires a cash
budget, but these two ratios provide quick, easy-to-use measures of liquidity:
Current assets $1,290,000
Current ratio = Current liabilities = $540,200
= 2.39 ×
INTEGRATIVE PROBLEM SOLUTIONS
a. Finance deals with decisions about money—that is, how money is raised and used by
companies and individuals. Because value is based on cash flows, finance is integral to
the successful operations of a firm. To be successful, a firm needs to understand how to
raise funds, how much it costs to use investors’ money, and how to appropriately invest
funds.
b. Everyone deals with financial decisions, both in business and in their personal lives. For
this reason, and because there are financial implications in nearly every business-related
decision, it is important that everyone has at least a general knowledge of financial
concepts so that they can make informed decisions about money. Marty should be
especially knowledgeable in finance, because he is a one-person operation—he is the
person who makes the financial decisions for his firm.
c. The three main forms of business organization are the proprietorship, the partnership, and
the corporation. Although proprietorships and partnerships are easy to start, the major
disadvantage to these forms of business is that the owners have unlimited personal liability
for the debts of the businesses. On the other hand, a corporation is more difficult to start
than the other forms of business, but owners have limited liability. Most business is
conducted by corporations because this organizational form maximizes firms’ values.
d. Mr. Kimble probably should organize as a proprietorship, because it is easy to start the
business as a proprietorship and it generally is more advantageous from a tax standpoint
for a small business to be organized as a proprietorship rather than as a corporation.
e. If the company is so successful that it grows to be a large organization, then Mr. Kimble
probably should change from a proprietorship to a corporation. A major reason for
changing to a corporation is to protect personal wealth—the owners of a corporation are
not personally liable for the debts of the business, whereas the owners of proprietorships
and partnerships are personally fully liable for all business debts. When a company
becomes very large, most owners believe that the limited liability offered by the corporate
form of business is extremely important.
f. Mr. Kimble should operate the business so that his best interests are met. Perhaps he
would like to maximize the value of his company, or perhaps he would prefer to maximize
his leisure time while making a good living with his business. Whatever goal(s) he
chooses, as long as he is sole owner of the company, Mr. Kimble can operate the business
, as he pleases. However, if he sells a portion of the company to investors, then Mr. Kimble
will have to pay more attention to the best interests of the investors—that is, he will have to
pursue the goal of maximizing the value of the firm.
g. After converting to a corporation and selling stock to outsiders, PAR will have multiple
owners, which means that Mr. Kimble and his management team will have to consider the
best interests of the other owners when making decisions about the corporation. Mr.
Kimble and his management team are “agents” of the stockholders, and they should
operate the business so as to maximize the value of the firm. To ensure that management
makes decisions that are in the best interests of the owners, the company can pay
incentives that are based on the success of the firm, make management owners of the
firms, or use other methods to encourage management to make the “correct” decisions.
Such methods will help to lessen the chances of management making decisions in their
own best interests rather than the stockholders’ best interests—that is, the chances of
agency problems will be mitigated.
h. U.S. and foreign companies “go international” for the following major reasons:
1. To seek new markets. After a company has saturated its home market, growth
opportunities often are better in foreign markets.
2. To seek raw materials.
3. To seek new technology. No single nation holds a commanding advantage in all
technologies, so companies scour the globe for leading scientific and design ideas.
4. To seek production efficiency. Companies in countries where production costs are high
tend to shift production to low-cost countries.
5. To avoid political and regulatory hurdles. For example, companies move production to
foreign countries in which they sell products to get around U.S. import quotas.
i. 1. Different currency denominations. Cash flows in various parts of a multinational
corporate system often are denominated in different currencies. Hence, an analysis of
exchange rates and the effects of fluctuating currency values must be included in all
financial analyses.
2. Economic and legal ramifications. Each country in which the firm operates has its own
unique political and economic institutions, and institutional differences among countries
can cause significant problems when a firm tries to coordinate and control the
worldwide operations of its subsidiaries. Such differences can restrict multinational
corporations’ flexibility to deploy resources as they wish and can even make
procedures illegal in one part of the company that are required in another part. These
differences also make it difficult for executives trained in one country to operate
effectively in another.
,3. Language differences. The ability to communicate is critical in all business
transactions.
4. Cultural differences. Even within geographic regions long considered fairly
homogeneous, different countries have unique cultural heritages that shape values and
influence the role of business in the society. Multinational corporations find that such
matters as defining the appropriate goals of the firm, attitudes toward risk taking,
dealing with employees, and the ability to curtail unprofitable operations can vary
dramatically from one country to the next.
5. Role of governments. Most traditional models in finance assume the existence of a
competitive marketplace in which the terms of trade are determined by the participants.
However, in foreign countries, in some instances, the terms under which companies
compete, the actions that must be taken or avoided, and the terms of trade on various
transactions are determined not in the marketplace but by direct negotiation between
the host government and the multinational corporation.
6. Political risk. The distinguishing characteristic that differentiates a nation from a
multinational corporation is that the nation exercises sovereignty over the people and
property in its territory. Hence, a nation is free to place constraints on the transfer of
corporate resources and even to expropriate—that is, take for public use—the assets
of a firm without compensation.
, CFIN4 - CHAPTER 2
INTEGRATIVE PROBLEM SOLUTION
a. Begin by reviewing briefly what balance sheets and income statements are. Then give an
overview of the statement of cash flows. Explain that some data (net income, depreciation,
and dividends) come from the income statement, while the other items reflect differences
between balance sheet accounts and thus show changes in those accounts between the
two dates.
The cash flow statement highlights some important aspects of Computron’s financial condition.
First, note that the firm’s net operating cash flow is -$73,780, so its operations are draining cash
despite the positive net income reported on the income statement. Second, because of its negative
cash flow from operations, Computron had to borrow a total of $126,180 in long- and short-term
debt to cover its operating cash outlays, to pay for fixed asset additions, and to pay dividends. Even
after all this borrowing, Computron’s cash account still fell by $5,600 during 2010.
b. Financial ratios are used to get an idea about how well the company is being operated,
and where it needs improving. The ratio categories, and their purposes, are as follows:
1. Liquidity: Can the company make required payments in the short run (defined as the
next year)?
2. Asset management: Are the investments in assets about right in view of sales levels?
3. Debt management (financing mix): Does the company have about the right amount of
debt, or is it over leveraged?
4. Profitability: Are costs under good control as reflected in the profit margin, ROE, and
ROE?
5. Market values: Do investors like what they see as reflected in the P/E and M/B ratios?
c. Computron has $540,200 in obligations that must be satisfied within the coming year. Will
it have trouble meeting its required payments? A full liquidity analysis requires a cash
budget, but these two ratios provide quick, easy-to-use measures of liquidity:
Current assets $1,290,000
Current ratio = Current liabilities = $540,200
= 2.39 ×
