End Of Chapter Solutions Manual
Essentials Of Corporate Finance 6th
Edition Ross, Westerfield, And Jordan
,CHAPTER 1
INTRODUCTION TO CORPORATE
FINANCE
Answers To Concepts Review And Critical Thinking Questions
1. Capital Budgeting (Deciding On 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, Hard To
Raise 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. Some Advantages Include: Limited Liability, Ease Of
Transferability, Ability To Raise Capital, And Unlimited Life.
4. The Treasurer’s Office And The Controller’s Office Are The Two Primary Organizational Groups
That Report Directly To The Chief Financial Officer. The Controller’s Office Handles Cost And
FinancialACCOUNTING, 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
Functions Of The Treasurer’s Office.
5. To Maximize The Current Market Value (Share Price) Of The Equity Of The Firm (Whether It’s
Publicly Traded Or Not).
6. 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. This Separation Of Ownership From Control In The Corporate Form Of Organization
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 Maximizing The Share Price Of The Equity Of The Firm.
7. A Primary Market Transaction.
8. In Auction Markets Like The NYSE, Brokers And Agents Meet At A Physical Location (The
Exchange) To Buy And Sell Their Assets. Dealer Markets Like Nasdaq Represent Dealers Operating
In
, CHAPTER 2 B-3
Dispersed Locales Who Buy And Sell Assets Themselves, Usually Communicating With Other
Dealers Electronically Or Literally Over The Counter.
9. Since Such Organizations Frequently Pursue Social Or Political Missions, Many Different Goals Are
Conceivable. One Goal That Is Often Cited Is Revenue Minimization; I.E., Providing Their Goods
And Services To Society At The Lowest Possible Cost. Another Approach Might Be To Observe
That Even A Not- For-Profit Business Has Equity. Thus, An Appropriate Goal Would Be To
Maximize The Value Of The Equity.
10. An Argument Can Be Made Either Way. At One Extreme, We Could Argue That In A Market
Economy, All Of These Things Are Priced. This Implies An Optimal Level Of Ethical And/Or
Illegal Behavior And The Framework Of Stock Valuation Explicitly Includes These. At The Other
Extreme, We Could Argue That These Are Non-Economic Phenomena And Are Best Handled
Through The Political Process. The Following Is 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?”
11. The Goal Will Be The Same, But The Best Course Of Action Toward That Goal May Require
Adjustments Due Different Social, Political, And Economic Climates.
12. The Goal Of Management Should Be To Maximize 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 Monitored Managers Have An Incentive To Fight Corporate Takeovers In Situations Such As
This.
13. We Would Expect Agency Problems To Be Less Severe In Other Countries, Primarily Due To The
Relatively Small Percentage Of Individual Ownership. Fewer Individual Owners Should Reduce The
Number Of Diverse Opinions Concerning Corporate Goals. The High Percentage Of Institutional
Ownership Might Lead To A Higher Degree Of Agreement Between Owners And Managers On
Decisions Concerning Risky Projects. In Addition, Institutions May Be Able To Implement More
Effective Monitoring Mechanisms Than Can Individual Owners, Given An Institutions’ Deeper
Resources And Experiences With Their Own Management. The Increase In Institutional Ownership
Of Stock In The United States And The Growing Activism Of These Large Shareholder Groups May
Lead To A Reduction In Agency Problems For U.S. Corporations And A More Efficient Market For
Corporate Control.
, SOLUTIONS B-4
14. How Much Is Too Much? Who Is Worth More, Steve Jobs Or Tiger Woods? The Simplest Answer
Is That There Is A Market For Executives Just As There Is For All Types Of Labor. Executive
Compensation Is The Price That Clears The Market. The Same Is True For Athletes And Performers.
Having Said That, One Aspect Of Executive Compensation Deserves Comment. A Primary Reason
Executive Compensation Has Grown So Dramatically Is That Companies Have Increasingly Moved
To Stock-Based Compensation. Such Movement Is Obviously Consistent With The Attempt To
Better Align Stockholder And Management Interests. In Recent Years, Stock Prices Have Soared, So
Management Has Cleaned Up. It Is Sometimes Argued That Much Of This Reward Is Simply Due
To Rising Stock Prices In General, Not Managerial Performance. Perhaps In The Future, Executive
Compensation Will Be Designed To Reward Only Differential Performance, I.E., Stock Price
Increases In Excess Of General Market Increases.
15. The Biggest Reason That A Company Would “Go Dark” Is Because Of The Increased Audit Costs
Associated With Sarbanes-Oxley Compliance. A Company Should Always Do A Cost-Benefit
Analysis, And It May Be The Case That The Costs Of Complying With Sarbox Outweigh The
Benefits. Of Course, The Company Could Always Be Trying To Hide Financial Issues Of The
Company! This Is Also One Of The Costs Of Going Dark: Investors Surely Believe That Some
Companies Are Going Dark To Avoid The Increased Scrutiny From Sarbox. This Taints Other
Companies That Go Dark Just To Avoid Compliance Costs. This Is Similar To The Lemon Problem
With Used Automobiles: Buyers Tend To Underpay Because They Know A Certain Percentage Of
Used Cars Are Lemons. So, Investors Will Tend To Pay Less For The Company Stock Than They
Otherwise Would. It Is Important To Note That Even If The Company Delists, Its Stock Is Still
Likely Traded, But On The Over-The-Counter Market Pink Sheets Rather Than On An Organized
Exchange. This Adds Another Cost Since The Stock Is Likely To Be Less Liquid Now. All Else The
Same, Investors Pay Less For An Asset With Less Liquidity. Overall, The Cost To The Company Is
Likely A Reduced Market Value. Whether Delisting Is Good Or Bad For Investors Depends On The
Individual Circumstances Of The Company. It Is Also Important To Remember That There Are
Already Many Small Companies That File Only Limited Financial Information Already.
Essentials Of Corporate Finance 6th
Edition Ross, Westerfield, And Jordan
,CHAPTER 1
INTRODUCTION TO CORPORATE
FINANCE
Answers To Concepts Review And Critical Thinking Questions
1. Capital Budgeting (Deciding On 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, Hard To
Raise 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. Some Advantages Include: Limited Liability, Ease Of
Transferability, Ability To Raise Capital, And Unlimited Life.
4. The Treasurer’s Office And The Controller’s Office Are The Two Primary Organizational Groups
That Report Directly To The Chief Financial Officer. The Controller’s Office Handles Cost And
FinancialACCOUNTING, 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
Functions Of The Treasurer’s Office.
5. To Maximize The Current Market Value (Share Price) Of The Equity Of The Firm (Whether It’s
Publicly Traded Or Not).
6. 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. This Separation Of Ownership From Control In The Corporate Form Of Organization
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 Maximizing The Share Price Of The Equity Of The Firm.
7. A Primary Market Transaction.
8. In Auction Markets Like The NYSE, Brokers And Agents Meet At A Physical Location (The
Exchange) To Buy And Sell Their Assets. Dealer Markets Like Nasdaq Represent Dealers Operating
In
, CHAPTER 2 B-3
Dispersed Locales Who Buy And Sell Assets Themselves, Usually Communicating With Other
Dealers Electronically Or Literally Over The Counter.
9. Since Such Organizations Frequently Pursue Social Or Political Missions, Many Different Goals Are
Conceivable. One Goal That Is Often Cited Is Revenue Minimization; I.E., Providing Their Goods
And Services To Society At The Lowest Possible Cost. Another Approach Might Be To Observe
That Even A Not- For-Profit Business Has Equity. Thus, An Appropriate Goal Would Be To
Maximize The Value Of The Equity.
10. An Argument Can Be Made Either Way. At One Extreme, We Could Argue That In A Market
Economy, All Of These Things Are Priced. This Implies An Optimal Level Of Ethical And/Or
Illegal Behavior And The Framework Of Stock Valuation Explicitly Includes These. At The Other
Extreme, We Could Argue That These Are Non-Economic Phenomena And Are Best Handled
Through The Political Process. The Following Is 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?”
11. The Goal Will Be The Same, But The Best Course Of Action Toward That Goal May Require
Adjustments Due Different Social, Political, And Economic Climates.
12. The Goal Of Management Should Be To Maximize 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 Monitored Managers Have An Incentive To Fight Corporate Takeovers In Situations Such As
This.
13. We Would Expect Agency Problems To Be Less Severe In Other Countries, Primarily Due To The
Relatively Small Percentage Of Individual Ownership. Fewer Individual Owners Should Reduce The
Number Of Diverse Opinions Concerning Corporate Goals. The High Percentage Of Institutional
Ownership Might Lead To A Higher Degree Of Agreement Between Owners And Managers On
Decisions Concerning Risky Projects. In Addition, Institutions May Be Able To Implement More
Effective Monitoring Mechanisms Than Can Individual Owners, Given An Institutions’ Deeper
Resources And Experiences With Their Own Management. The Increase In Institutional Ownership
Of Stock In The United States And The Growing Activism Of These Large Shareholder Groups May
Lead To A Reduction In Agency Problems For U.S. Corporations And A More Efficient Market For
Corporate Control.
, SOLUTIONS B-4
14. How Much Is Too Much? Who Is Worth More, Steve Jobs Or Tiger Woods? The Simplest Answer
Is That There Is A Market For Executives Just As There Is For All Types Of Labor. Executive
Compensation Is The Price That Clears The Market. The Same Is True For Athletes And Performers.
Having Said That, One Aspect Of Executive Compensation Deserves Comment. A Primary Reason
Executive Compensation Has Grown So Dramatically Is That Companies Have Increasingly Moved
To Stock-Based Compensation. Such Movement Is Obviously Consistent With The Attempt To
Better Align Stockholder And Management Interests. In Recent Years, Stock Prices Have Soared, So
Management Has Cleaned Up. It Is Sometimes Argued That Much Of This Reward Is Simply Due
To Rising Stock Prices In General, Not Managerial Performance. Perhaps In The Future, Executive
Compensation Will Be Designed To Reward Only Differential Performance, I.E., Stock Price
Increases In Excess Of General Market Increases.
15. The Biggest Reason That A Company Would “Go Dark” Is Because Of The Increased Audit Costs
Associated With Sarbanes-Oxley Compliance. A Company Should Always Do A Cost-Benefit
Analysis, And It May Be The Case That The Costs Of Complying With Sarbox Outweigh The
Benefits. Of Course, The Company Could Always Be Trying To Hide Financial Issues Of The
Company! This Is Also One Of The Costs Of Going Dark: Investors Surely Believe That Some
Companies Are Going Dark To Avoid The Increased Scrutiny From Sarbox. This Taints Other
Companies That Go Dark Just To Avoid Compliance Costs. This Is Similar To The Lemon Problem
With Used Automobiles: Buyers Tend To Underpay Because They Know A Certain Percentage Of
Used Cars Are Lemons. So, Investors Will Tend To Pay Less For The Company Stock Than They
Otherwise Would. It Is Important To Note That Even If The Company Delists, Its Stock Is Still
Likely Traded, But On The Over-The-Counter Market Pink Sheets Rather Than On An Organized
Exchange. This Adds Another Cost Since The Stock Is Likely To Be Less Liquid Now. All Else The
Same, Investors Pay Less For An Asset With Less Liquidity. Overall, The Cost To The Company Is
Likely A Reduced Market Value. Whether Delisting Is Good Or Bad For Investors Depends On The
Individual Circumstances Of The Company. It Is Also Important To Remember That There Are
Already Many Small Companies That File Only Limited Financial Information Already.
