CHAPTER 1 t
Introduction to Corporate Finance t t t
The values shown in the solutions may be rounded for display purposes. However, the answers
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werederived using a spreadsheet without any intermediate rounding.
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Answers to Problem Sets t t t
1. a. real
b. executive airplanes t
c. brand names t
d. financial
e. bonds
*f. investment or capital expenditure t t t
*g. capital budgeting or investment t t t
h. financing
*Note that f and g are interchangeable in the question.
t t t t t t t t t
Est time: 01-05
t t
2. A trademark, a factory, undeveloped land, and your work force (c, d, e, and g) are
t t t t t t t t t t t t t t t
all real assets. Real assets are identifiable as items with intrinsic value. The others in
t t t t t t t t t t t t t t t
the list are financial assets,that is, these assets derive value because of a contractu
t t t t t t t t t t t t t t t
al claim. t
Est time: 01-05
t t
3. a.
Financial assets, such as stocks or bank loans, are claims held by inves
t t t t t t t t t t t t
tors. Corporations sell financial assets to raise the cash to invest in real ass
t t t t t t t t t t t t t
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
, ets such as plantand equipment. Some real assets are intangible.
t t t t t t t t t t
b. Capital expenditure means investment in real assets. Financing means rais
t t t t t t t t t
ing the cashfor this investment.
t t t t t
c. The shares of public corporations are traded on stock exchanges and can
t t t t t t t t t t t t
be purchasedby a wide range of investors. The shares of closely held corp
t t t t t t t t t t t t t
orations are not publicly traded and are held by a small group of private i
t t t t t t t t t t t t t t
nvestors.
d. Unlimited liability: Investors are responsible for all the firm‘s debts. A sole
t t t t t t t t t t t t
proprietor hasunlimited liability. Investors in corporations have limited lia
t t t t t t t t t
bility. They can lose their investment, but no more.
t t t t t t t t
Est time: 01-05
t t
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
,4. Items c and d apply to corporations. Because corporations have perpetual life, ow
t t t t t t t t t t t t
nership can betransferred without affecting operations, and managers can be fir
t t t t t t t t t t t
ed with no effect on ownership. Other forms of business may have unlimited liabilit
t t t t t t t t t t t t t
y and limited life.
t t t
Est time: 01-05
t t
5. Separation of ownership facilitates the key attributes of a corporation, including l
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imited liability forinvestors, transferability of ownership, a separate legal person
t t t t t t t t t t
ality of the corporation, and delegated centralized management. These four attri
t t t t t t t t t t
butes provide substantial benefit for investors, including the ability to diversify th
t t t t t t t t t t t
eir investment among many uncorrelated returns—
t t t t t
a very valuable tool explored in later chapters. Also, these attributes allow invest
t t t t t t t t t t t t
ors to quickly exit,enter, or short sell an investment, thereby generating an active li
t t t t t t t t t t t t t t
quid market for corporations.
t t t
However, these positive aspects also introduce substantial negative externalities
t t t t t t t t t
as well. The separation of ownership from management typically leads to agency
t t t t t t t t t t t t
problems, where managersprefer to consume private perks or make other decisio
t t t t t t t t t t t
ns for their private benefit—
t t t t
rather than maximize shareholder wealth. Shareholders tend to exercise less over
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sight of each individual investment as their diversification increases. Finally, the cor
t t t t t t t t t t t
poration‘s separate legal personalitymakes it difficult to enforce accountability if
t t t t t t t t t t t
they externalize costs onto society.
t t t t
Est time: 01-05
t t
6. Shareholders will only vote to maximize shareholder wealth. Shareholders ca t t t t t t t t t
n modify their pattern of consumption through borrowing and lending, match ri
t t t t t t t t t t t
sk preferences, and hopefullybalance their own checkbooks (or hire a qualifie
t t t t t t t t t t t
d professional to help them with these tasks).
t t t t t t t
Est time: 01-05
t t
7. If the investment increases the firm‘s wealth, it increases the firm‘s share value. M
t t t t t t t t t t t t t
s. Espinozacould then sell some or all these more valuable shares to provide for h
t t t t t t t t t t t t t t t
er retirement income.
t t
Est time: 01-05
t t
8. a.
Assuming that the encabulator market is risky, an 8% ex t t t t t t t t t
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
, pected return onthe F&H encabulator investments may be inf
t t t t t t t t t
erior to a 4% return on U.S.
t t t t t t
government securities, depending on the relative risk between the two assets.
t t t t t t t t t t
b.
Unless the financial assets are as safe as U.S. government securities, the
t t t t t t t t t t t
ir cost of capitalwould be higher. The CFO could consider expected returns
t t t t t t t t t t t t t
on assets with similar risk. t t t t
Est time: 06-10
t t
9. Managers would act in shareholders‘ interests because they have a legal duty to a
t t t t t t t t t t t t t
ct in their interests. Managers may also receive compensation—
t t t t t t t t
bonuses, stock, and option payouts with value tied (roughly) to firm performance.
t t t t t t t t t t t t t
Managers may fear personal reputational damage from not acting in shareholde
t t t t t t t t t t
rs‘ interests. And managers can be fired by the board of directors (electedby share
t t t t t t t t t t t t t t
holders). If managers still fail to act in shareholders‘ interests, shareholders may se
t t t t t t t t t t t t
ll their shares, lowering the stock price and potentially creating the possibility of a t
t t t t t t t t t t t t t t
akeover, which can again lead to changes in the board of directors and senior man
t t t t t t t t t t t t t t
agement.
Est time: 01-05
t t
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
Introduction to Corporate Finance t t t
The values shown in the solutions may be rounded for display purposes. However, the answers
t t t t t t t t t t t t t t t
werederived using a spreadsheet without any intermediate rounding.
t t t t t t t t
Answers to Problem Sets t t t
1. a. real
b. executive airplanes t
c. brand names t
d. financial
e. bonds
*f. investment or capital expenditure t t t
*g. capital budgeting or investment t t t
h. financing
*Note that f and g are interchangeable in the question.
t t t t t t t t t
Est time: 01-05
t t
2. A trademark, a factory, undeveloped land, and your work force (c, d, e, and g) are
t t t t t t t t t t t t t t t
all real assets. Real assets are identifiable as items with intrinsic value. The others in
t t t t t t t t t t t t t t t
the list are financial assets,that is, these assets derive value because of a contractu
t t t t t t t t t t t t t t t
al claim. t
Est time: 01-05
t t
3. a.
Financial assets, such as stocks or bank loans, are claims held by inves
t t t t t t t t t t t t
tors. Corporations sell financial assets to raise the cash to invest in real ass
t t t t t t t t t t t t t
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
, ets such as plantand equipment. Some real assets are intangible.
t t t t t t t t t t
b. Capital expenditure means investment in real assets. Financing means rais
t t t t t t t t t
ing the cashfor this investment.
t t t t t
c. The shares of public corporations are traded on stock exchanges and can
t t t t t t t t t t t t
be purchasedby a wide range of investors. The shares of closely held corp
t t t t t t t t t t t t t
orations are not publicly traded and are held by a small group of private i
t t t t t t t t t t t t t t
nvestors.
d. Unlimited liability: Investors are responsible for all the firm‘s debts. A sole
t t t t t t t t t t t t
proprietor hasunlimited liability. Investors in corporations have limited lia
t t t t t t t t t
bility. They can lose their investment, but no more.
t t t t t t t t
Est time: 01-05
t t
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
,4. Items c and d apply to corporations. Because corporations have perpetual life, ow
t t t t t t t t t t t t
nership can betransferred without affecting operations, and managers can be fir
t t t t t t t t t t t
ed with no effect on ownership. Other forms of business may have unlimited liabilit
t t t t t t t t t t t t t
y and limited life.
t t t
Est time: 01-05
t t
5. Separation of ownership facilitates the key attributes of a corporation, including l
t t t t t t t t t t t
imited liability forinvestors, transferability of ownership, a separate legal person
t t t t t t t t t t
ality of the corporation, and delegated centralized management. These four attri
t t t t t t t t t t
butes provide substantial benefit for investors, including the ability to diversify th
t t t t t t t t t t t
eir investment among many uncorrelated returns—
t t t t t
a very valuable tool explored in later chapters. Also, these attributes allow invest
t t t t t t t t t t t t
ors to quickly exit,enter, or short sell an investment, thereby generating an active li
t t t t t t t t t t t t t t
quid market for corporations.
t t t
However, these positive aspects also introduce substantial negative externalities
t t t t t t t t t
as well. The separation of ownership from management typically leads to agency
t t t t t t t t t t t t
problems, where managersprefer to consume private perks or make other decisio
t t t t t t t t t t t
ns for their private benefit—
t t t t
rather than maximize shareholder wealth. Shareholders tend to exercise less over
t t t t t t t t t t
sight of each individual investment as their diversification increases. Finally, the cor
t t t t t t t t t t t
poration‘s separate legal personalitymakes it difficult to enforce accountability if
t t t t t t t t t t t
they externalize costs onto society.
t t t t
Est time: 01-05
t t
6. Shareholders will only vote to maximize shareholder wealth. Shareholders ca t t t t t t t t t
n modify their pattern of consumption through borrowing and lending, match ri
t t t t t t t t t t t
sk preferences, and hopefullybalance their own checkbooks (or hire a qualifie
t t t t t t t t t t t
d professional to help them with these tasks).
t t t t t t t
Est time: 01-05
t t
7. If the investment increases the firm‘s wealth, it increases the firm‘s share value. M
t t t t t t t t t t t t t
s. Espinozacould then sell some or all these more valuable shares to provide for h
t t t t t t t t t t t t t t t
er retirement income.
t t
Est time: 01-05
t t
8. a.
Assuming that the encabulator market is risky, an 8% ex t t t t t t t t t
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
, pected return onthe F&H encabulator investments may be inf
t t t t t t t t t
erior to a 4% return on U.S.
t t t t t t
government securities, depending on the relative risk between the two assets.
t t t t t t t t t t
b.
Unless the financial assets are as safe as U.S. government securities, the
t t t t t t t t t t t
ir cost of capitalwould be higher. The CFO could consider expected returns
t t t t t t t t t t t t t
on assets with similar risk. t t t t
Est time: 06-10
t t
9. Managers would act in shareholders‘ interests because they have a legal duty to a
t t t t t t t t t t t t t
ct in their interests. Managers may also receive compensation—
t t t t t t t t
bonuses, stock, and option payouts with value tied (roughly) to firm performance.
t t t t t t t t t t t t t
Managers may fear personal reputational damage from not acting in shareholde
t t t t t t t t t t
rs‘ interests. And managers can be fired by the board of directors (electedby share
t t t t t t t t t t t t t t
holders). If managers still fail to act in shareholders‘ interests, shareholders may se
t t t t t t t t t t t t
ll their shares, lowering the stock price and potentially creating the possibility of a t
t t t t t t t t t t t t t t
akeover, which can again lead to changes in the board of directors and senior man
t t t t t t t t t t t t t t
agement.
Est time: 01-05
t t
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
