Solution Manual For
Principles of Corporate Finance
Author: Richard Brealey
14th Edition
,Chapter 1
Introduction To Corporate Finance
The Values Shown In The Solutions May Be Rounded For Display Purposes. However, The Answers Were
Derived Using A Spreadsheet Without Any Intermediate Rounding.
Answers To Problem Sets
1. A. Real
B. Executive Airplanes
C. Brand Names
D. Financial
E. Bonds
*F. Investment Or Capital Expenditure
*G. Capital Budgeting Or Investment
H. Financing
*Note That F And G Are Interchangeable In The Question.
Est Time: 01-05
,2. A Trademark, A Factory, Undeveloped Land, And Your Work Force (C, D, E, And G) Are All Real
Assets. Real Assets Are Identifiable As Items With Intrinsic Value. The Others In The List Are Financial
Assets, That Is, These Assets Derive Value Because Of A Contractual Claim.
Est Time: 01-05
3. A. Financial Assets, Such As Stocks Or Bank Loans, Are Claims Held By Investors.
Corporations Sell Financial Assets To Raise The Cash To Invest In Real Assets Such As Plant And
Equipment. Some Real Assets Are Intangible.
B. Capital Expenditure Means Investment In Real Assets. Financing Means Raising The Cash For
This Investment.
C. The Shares Of Public Corporations Are Traded On Stock Exchanges And Can Be Purchased By A
Wide Range Of Investors. The Shares Of Closely Held Corporations Are Not Publicly Traded And Are Held
By A Small Group Of Private Investors.
D. Unlimited Liability: Investors Are Responsible For All The Firm‘S Debts. A Sole Proprietor Has
Unlimited Liability. Investors In Corporations Have Limited Liability. They Can Lose Their Investment, But
No More.
Est Time: 01-05
4. Items C And D Apply To Corporations. Because Corporations Have Perpetual Life, Ownership Can
Be Transferred Without Affecting Operations, And Managers Can Be Fired With No Effect On Ownership.
Other Forms Of Business May Have Unlimited Liability And Limited Life.
Est Time: 01-05
5. Separation Of Ownership Facilitates The Key Attributes Of A Corporation, Including Limited
Liability For Investors, Transferability Of Ownership, A Separate Legal Personality Of The Corporation,
, And Delegated Centralized Management. These Four Attributes Provide Substantial Benefit For
Investors, Including The Ability To Diversify Their Investment Among Many Uncorrelated Returns—A
Very Valuable Tool Explored In Later Chapters. Also, These Attributes Allow Investors To Quickly Exit,
Enter, Or Short Sell An Investment, Thereby Generating An Active Liquid Market For Corporations.
However, These Positive Aspects Also Introduce Substantial Negative Externalities As Well. The
Separation Of Ownership From Management Typically Leads To Agency Problems, Where Managers
Prefer To Consume Private Perks Or Make Other Decisions For Their Private Benefit—Rather Than
Maximize Shareholder Wealth. Shareholders Tend To Exercise Less Oversight Of Each Individual
Investment As Their Diversification Increases. Finally, The Corporation‘S Separate Legal Personality
Makes It Difficult To Enforce Accountability If They Externalize Costs Onto Society.
Est Time: 01-05
6. Shareholders Will Only Vote To Maximize Shareholder Wealth. Shareholders Can Modify Their
Pattern Of Consumption Through Borrowing And Lending, Match Risk Preferences, And Hopefully
Balance Their Own Checkbooks (Or Hire A Qualified Professional To Help Them With These Tasks).
Est Time: 01-05
7. If The Investment Increases The Firm‘S Wealth, It Increases The Firm‘S Share Value. Ms.
Espinoza Could Then Sell Some Or All These More Valuable Shares To Provide For Her Retirement
Income.
Est Time: 01-05
8. A. Assuming That The Encabulator Market Is Risky, An 8% Expected Return On The F&H
Encabulator Investments May Be Inferior To A 4% Return On U.S.
Government Securities, Depending On The Relative Risk Between The Two Assets.
B. Unless The Financial Assets Are As Safe As U.S. Government Securities, Their Cost Of Capital
Would Be Higher. The Cfo Could Consider Expected Returns On Assets With Similar Risk.
Principles of Corporate Finance
Author: Richard Brealey
14th Edition
,Chapter 1
Introduction To Corporate Finance
The Values Shown In The Solutions May Be Rounded For Display Purposes. However, The Answers Were
Derived Using A Spreadsheet Without Any Intermediate Rounding.
Answers To Problem Sets
1. A. Real
B. Executive Airplanes
C. Brand Names
D. Financial
E. Bonds
*F. Investment Or Capital Expenditure
*G. Capital Budgeting Or Investment
H. Financing
*Note That F And G Are Interchangeable In The Question.
Est Time: 01-05
,2. A Trademark, A Factory, Undeveloped Land, And Your Work Force (C, D, E, And G) Are All Real
Assets. Real Assets Are Identifiable As Items With Intrinsic Value. The Others In The List Are Financial
Assets, That Is, These Assets Derive Value Because Of A Contractual Claim.
Est Time: 01-05
3. A. Financial Assets, Such As Stocks Or Bank Loans, Are Claims Held By Investors.
Corporations Sell Financial Assets To Raise The Cash To Invest In Real Assets Such As Plant And
Equipment. Some Real Assets Are Intangible.
B. Capital Expenditure Means Investment In Real Assets. Financing Means Raising The Cash For
This Investment.
C. The Shares Of Public Corporations Are Traded On Stock Exchanges And Can Be Purchased By A
Wide Range Of Investors. The Shares Of Closely Held Corporations Are Not Publicly Traded And Are Held
By A Small Group Of Private Investors.
D. Unlimited Liability: Investors Are Responsible For All The Firm‘S Debts. A Sole Proprietor Has
Unlimited Liability. Investors In Corporations Have Limited Liability. They Can Lose Their Investment, But
No More.
Est Time: 01-05
4. Items C And D Apply To Corporations. Because Corporations Have Perpetual Life, Ownership Can
Be Transferred Without Affecting Operations, And Managers Can Be Fired With No Effect On Ownership.
Other Forms Of Business May Have Unlimited Liability And Limited Life.
Est Time: 01-05
5. Separation Of Ownership Facilitates The Key Attributes Of A Corporation, Including Limited
Liability For Investors, Transferability Of Ownership, A Separate Legal Personality Of The Corporation,
, And Delegated Centralized Management. These Four Attributes Provide Substantial Benefit For
Investors, Including The Ability To Diversify Their Investment Among Many Uncorrelated Returns—A
Very Valuable Tool Explored In Later Chapters. Also, These Attributes Allow Investors To Quickly Exit,
Enter, Or Short Sell An Investment, Thereby Generating An Active Liquid Market For Corporations.
However, These Positive Aspects Also Introduce Substantial Negative Externalities As Well. The
Separation Of Ownership From Management Typically Leads To Agency Problems, Where Managers
Prefer To Consume Private Perks Or Make Other Decisions For Their Private Benefit—Rather Than
Maximize Shareholder Wealth. Shareholders Tend To Exercise Less Oversight Of Each Individual
Investment As Their Diversification Increases. Finally, The Corporation‘S Separate Legal Personality
Makes It Difficult To Enforce Accountability If They Externalize Costs Onto Society.
Est Time: 01-05
6. Shareholders Will Only Vote To Maximize Shareholder Wealth. Shareholders Can Modify Their
Pattern Of Consumption Through Borrowing And Lending, Match Risk Preferences, And Hopefully
Balance Their Own Checkbooks (Or Hire A Qualified Professional To Help Them With These Tasks).
Est Time: 01-05
7. If The Investment Increases The Firm‘S Wealth, It Increases The Firm‘S Share Value. Ms.
Espinoza Could Then Sell Some Or All These More Valuable Shares To Provide For Her Retirement
Income.
Est Time: 01-05
8. A. Assuming That The Encabulator Market Is Risky, An 8% Expected Return On The F&H
Encabulator Investments May Be Inferior To A 4% Return On U.S.
Government Securities, Depending On The Relative Risk Between The Two Assets.
B. Unless The Financial Assets Are As Safe As U.S. Government Securities, Their Cost Of Capital
Would Be Higher. The Cfo Could Consider Expected Returns On Assets With Similar Risk.
