Solution Manual for
Principles of Corporate
Finance 14th Edition by
Richard Brealey, Stewart
Myers, Franklin Allen and
Alex Edmans
1. Question: What is the primary goal of financial management?
Answer: The primary goal of financial management is to maximize the value of the firm for its
shareholders. This involves making investment, financing, and dividend decisions that enhance
the firm's long-term profitability and market value.
2. Question: Explain the concept of the time value of money (TVM).
Answer: The time value of money is a financial principle stating that a dollar today is worth
more than a dollar in the future due to its potential earning capacity. This concept is foundational
for valuing cash flows that occur at different times, and it is calculated using present value and
future value formulas.
3. Question: What is the difference between systematic risk and
unsystematic risk?
Answer:
, ● Systematic risk (market risk) is the risk inherent to the entire market or market
segment, which cannot be eliminated through diversification. It is influenced by factors
such as economic changes, political events, and natural disasters.
● Unsystematic risk (specific risk) is the risk associated with a specific company or
industry. It can be reduced or eliminated through diversification in a portfolio of assets.
4. Question: Describe the capital asset pricing model (CAPM) and its
components.
Answer: The Capital Asset Pricing Model (CAPM) is a formula used to determine the expected
return on an asset based on its systematic risk (beta). The formula is:
Expected Return=Rf+β(Rm−Rf)\text{Expected Return} = R_f + \beta (R_m -
R_f)Expected Return=Rf+β(Rm−Rf)
Where:
● RfR_fRf = risk-free rate
● β\betaβ = measure of the asset's volatility relative to the market
● RmR_mRm = expected market return
● (Rm−Rf)(R_m - R_f)(Rm−Rf) = market risk premium
5. Question: What are the advantages and disadvantages of debt
financing?
Answer:
● Advantages:
○ Interest payments on debt are tax-deductible, reducing the overall cost of
borrowing.
○ Debt financing does not dilute ownership, allowing existing shareholders to
maintain control.
● Disadvantages:
○ Increased debt can lead to higher financial risk and potential bankruptcy if the
firm cannot meet its obligations.
○ Fixed interest payments can strain cash flow, especially in economic downturns.
6. Question: Define the weighted average cost of capital (WACC) and its
significance.
Answer: WACC is the average rate that a company is expected to pay to finance its assets,
weighted by the proportion of each component of capital (equity, debt, etc.). It is calculated as:
, WACC=EV⋅re+DV⋅rd(1−T)\text{WACC} = \frac{E}{V} \cdot r_e + \frac{D}{V} \
cdot r_d (1 - T)WACC=VE⋅re+VD⋅rd(1−T)
Where:
● EEE = market value of equity
● DDD = market value of debt
● VVV = total market value of the firm's financing (equity + debt)
● rer_ere = cost of equity
● rdr_drd = cost of debt
● TTT = corporate tax rate
WACC is significant as it is used as a hurdle rate for investment decisions; projects must have a
return greater than WACC to add value.
7. Question: What is the purpose of a cash flow statement?
Answer: The cash flow statement provides an overview of the cash inflows and outflows from
operating, investing, and financing activities over a specific period. It helps stakeholders assess
the company's liquidity, solvency, and financial flexibility, revealing how well the company
generates cash to meet its obligations and fund its operations.
8. Question: What is the difference between a primary market and a
secondary market?
Answer:
● Primary Market: This is where new securities are issued and sold for the first time,
allowing companies to raise capital. Investors purchase securities directly from the
issuer.
● Secondary Market: This is where existing securities are traded among investors. The
issuing company does not receive any funds from these transactions, as they occur
between investors.
9. Question: What is the role of the board of directors in a corporation?
Answer: The board of directors is responsible for overseeing the management of the
corporation and making decisions in the best interest of shareholders. They provide strategic
direction, approve major corporate policies, and ensure that the company adheres to legal and
ethical standards.
Principles of Corporate
Finance 14th Edition by
Richard Brealey, Stewart
Myers, Franklin Allen and
Alex Edmans
1. Question: What is the primary goal of financial management?
Answer: The primary goal of financial management is to maximize the value of the firm for its
shareholders. This involves making investment, financing, and dividend decisions that enhance
the firm's long-term profitability and market value.
2. Question: Explain the concept of the time value of money (TVM).
Answer: The time value of money is a financial principle stating that a dollar today is worth
more than a dollar in the future due to its potential earning capacity. This concept is foundational
for valuing cash flows that occur at different times, and it is calculated using present value and
future value formulas.
3. Question: What is the difference between systematic risk and
unsystematic risk?
Answer:
, ● Systematic risk (market risk) is the risk inherent to the entire market or market
segment, which cannot be eliminated through diversification. It is influenced by factors
such as economic changes, political events, and natural disasters.
● Unsystematic risk (specific risk) is the risk associated with a specific company or
industry. It can be reduced or eliminated through diversification in a portfolio of assets.
4. Question: Describe the capital asset pricing model (CAPM) and its
components.
Answer: The Capital Asset Pricing Model (CAPM) is a formula used to determine the expected
return on an asset based on its systematic risk (beta). The formula is:
Expected Return=Rf+β(Rm−Rf)\text{Expected Return} = R_f + \beta (R_m -
R_f)Expected Return=Rf+β(Rm−Rf)
Where:
● RfR_fRf = risk-free rate
● β\betaβ = measure of the asset's volatility relative to the market
● RmR_mRm = expected market return
● (Rm−Rf)(R_m - R_f)(Rm−Rf) = market risk premium
5. Question: What are the advantages and disadvantages of debt
financing?
Answer:
● Advantages:
○ Interest payments on debt are tax-deductible, reducing the overall cost of
borrowing.
○ Debt financing does not dilute ownership, allowing existing shareholders to
maintain control.
● Disadvantages:
○ Increased debt can lead to higher financial risk and potential bankruptcy if the
firm cannot meet its obligations.
○ Fixed interest payments can strain cash flow, especially in economic downturns.
6. Question: Define the weighted average cost of capital (WACC) and its
significance.
Answer: WACC is the average rate that a company is expected to pay to finance its assets,
weighted by the proportion of each component of capital (equity, debt, etc.). It is calculated as:
, WACC=EV⋅re+DV⋅rd(1−T)\text{WACC} = \frac{E}{V} \cdot r_e + \frac{D}{V} \
cdot r_d (1 - T)WACC=VE⋅re+VD⋅rd(1−T)
Where:
● EEE = market value of equity
● DDD = market value of debt
● VVV = total market value of the firm's financing (equity + debt)
● rer_ere = cost of equity
● rdr_drd = cost of debt
● TTT = corporate tax rate
WACC is significant as it is used as a hurdle rate for investment decisions; projects must have a
return greater than WACC to add value.
7. Question: What is the purpose of a cash flow statement?
Answer: The cash flow statement provides an overview of the cash inflows and outflows from
operating, investing, and financing activities over a specific period. It helps stakeholders assess
the company's liquidity, solvency, and financial flexibility, revealing how well the company
generates cash to meet its obligations and fund its operations.
8. Question: What is the difference between a primary market and a
secondary market?
Answer:
● Primary Market: This is where new securities are issued and sold for the first time,
allowing companies to raise capital. Investors purchase securities directly from the
issuer.
● Secondary Market: This is where existing securities are traded among investors. The
issuing company does not receive any funds from these transactions, as they occur
between investors.
9. Question: What is the role of the board of directors in a corporation?
Answer: The board of directors is responsible for overseeing the management of the
corporation and making decisions in the best interest of shareholders. They provide strategic
direction, approve major corporate policies, and ensure that the company adheres to legal and
ethical standards.
