SOLUTION MANUAL
Foundations of Financial Management, 18th Edition by Stanley
Block, Geoffrey Hirt, Bartley Danielsen
Chapter`1
The`Goals`and`Functions`of`Financial`Management
Discussion`Questions
1-1 What`effect`did`the`recession`of`2007-2009`have`on`government`regulation?
It`was`greatly`increased.
1-2 What`advantages`does`a`sole`proprietorship`offer?`What`is`a`major`drawback`of`this`type`
of`organization?
A`sole`proprietorship`offers`the`advantage`of`simplicity`of`decision`making`and`low`organ
izational`and`operating`costs.`A`major`drawback`is`that`there`is`unlimited`liability`to`the`o
wner.
1-3 What`form`of`partnership`allows`some`of`the`investors`to`limit`their`liability? `Explain`
briefly.
A`limited`partnership`allows`some`of`the`partners`to`limit`their`liability.`Under`this`arrang
ement,`one`or`more`partners`are`designated`general`partners`and`have`unlimited`liability`fo
r`the`debts`of`the`firm;`other`partners`are`designated`limited`partners`and`are`liable`only`for
`their`initial`contribution.`The`limited`partners`are`normally`prohibited`from`being`active`in
`the`management`of`the`firm.
1-4 In`a`corporation,`what`group`has`the`ultimate`responsibility`for`protecting`and`managing`t
he`stockholders’`interests?
The`board`of`directors.
1-5 What`document`is`necessary`to`form`a`corporation?
The`articles`of`incorporation.
1-6 What`issue`does`agency`theory`examine?`Why`is`it`important`in`a`public`corporation`
rather`than`in`a`private`corporation?
, Agency`theory`examines`the`relationship`between`the`owners`of`the`firm`and`the`manager
s`of`the`firm.`In`privately`owned`firms,`management`and`the`owners`are`usually`the`same`p
eople.`Management`operates`the`firm`to`satisfy`its`own`goals,`needs,`financial`requirement
s`and`the`like.`As`a`company`moves`from`private`to`public`ownership,`management`now`r
epresents`all`owners.`This`places`management`in`the`agency`position`of`making`decisions`
in`the`best`interest`of`all`shareholders.
1-7 What`are`institutional`investors`important`in`today’s`business`world?
Because`institutional`investors`such`as`pension`funds`and`mutual`funds`own`a`large`percent
age`of`major`U.S.`companies,`they`are`having`more`to`say`about`the`way`publicly`owned`co
mpanies`are`managed.`As`a`group,`they`have`the`ability`to`vote`large`blocks`of`shares`for`th
e`election`of`a`board`of`directors,`which`is`supposed`to`run`the`company`in`an`efficient,`com
petitive`manner.`The`threat`of`being`able`to`replace`poor`performing`boards`of`directors`ma
kes`institutional`investors`quite`influential.`Since`these`institutions,`like`pension`funds`and`
mutual`funds,`represent`individual`workers`and`investors,`they`have`a`responsibility`to`see`t
hat`the`firm`is`managed`in`an`efficient`and`ethical`way.
1-8 Why`is`profit`maximization,`by`itself,`an`inappropriate`goal?`What`is`meant`by`the`goal`
of`maximization`of`shareholder`wealth?
The`problem`with`a`profit`maximization`goal`is`that`it`fails`to`take`account`of`risk,`the`timi
ng`of`the`benefits`is`not`considered,`and`profit`measurement`is`a`very`inexact`process.`The`
goal`of`shareholders’`wealth`maximization`implies`that`the`firm`will`attempt`to`achieve`th
e`highest`possible`total`valuation`in`the`marketplace.`It`is`the`one`overriding`objective`of`t
he`firm`and`should`influence`every`decision.
1-9 When`does`insider`trading`occur?`What`government`agency`is`responsible`for`protecting`
against`the`unethical`practice`of`insider`trading?
Insider`trading`occurs`when`anyone`with`non-
public`information`buys`or`sells`securities`to`take`advantage`of`that`private`information.`T
he`Securities`and`Exchange`Commission`is`responsible`for`protecting`markets`against`insi
der`trading.`In`the`past,`people`have`gone`to`jail`for`trading`on`non-
public`information.`This`has`included`company`officers,`investment`bankers,`printers`who
`have`information`before`it`is`published,`and`even`truck`drivers`who`deliver`business`maga
zines`and`read`positive`or`negative`articles`about`a`company`before`the`magazine`is`on`the`
newsstands`and`then`place`trades`or`have`friends`place`trades`based`on`that`information.`T
he`SEC`has`prosecuted`anyone`who`profits`from`inside`information.
1-10 In`terms`of`the`life`of`the`securities`offered,`what`is`the`difference`between`money`and`
capital`markets?
Money`markets`refer`to`those`markets`dealing`with`short-
term`securities`that`have`a`life`of`one`year`or`less.`Capital`markets`refer`to`securities`with`
a`life`of`more`than`one`year.
1-11 What`is`the`difference`between`a`primary`and`a`secondary`market?
, A`primary`market`refers`to`the`use`of`the`financial`markets`to`raise`new`funds`for`the`corp
oration.`After`the`securities`are`sold`to`the`public`(institutions`and`individuals),`they`trade`i
n`the`secondary`market`between`investors.`It`is`in`the`secondary`market`that`prices`are`cont
inually`changing`as`investors`buy`and`sell`securities`based`on`the`expectations`of`corporate
`prospects.
1-12 Assume`you`are`looking`at`many`companies`with`equal`risk.`Which`ones`will`have`the`
highest`stock`prices?
Given`companies`with`equal`risk,`those`companies`with`expectations`of`high`return`will`
have`higher`common`stock`prices`relative`to`those`companies`with`expectations`of`poor`
returns.
1-13 How`is`the`time`value`of`money`concept`related`to`the`valuation`of`stocks?
The`value`of`an`investment`that`is`expected`to`earn`money`in`the`future`can`be`calculated`u
sing`time-
value`of`money`principles.`Corporations`are`expected`to`pay`dividends`to`their`shareholder
s.`The`current`value`of`these`future`dividends`is`the`present`value.`The`present`value`of`a`st
ock’s`future`dividends`should`be`the`same`as`the`stock’s`current`price.
Chapter`2
Review`of`Accounting
Discussion`Questions
2-1. Discuss`some`financial`variables`that`affect`the`price-earnings`ratio.
The`price-
earnings`ratio`will`be`influenced`by`the`earnings`and`sales`growth`of`the`firm,`the`risk`
or`volatility`in`performance,`the`debt-
equity`structure`of`the`firm,`the`dividend`payment`policy,`the`quality`of`management,`
and`a`number`of`other`factors.`The`ratio`tends`to`be`future-
oriented,`and`the`more`positive`the`outlook,`the`higher`it`will`be.
2-2. What`is`the`difference`between`book`value`per`share`of`common`stock`and`market`val
ue`per`share?`Why`does`this`disparity`occur?
Book`value`per`share`is`arrived`at`by`taking`the`cost`of`the`assets`and`subtracting`out`li
abilities`and`preferred`stock`and`dividing`by`the`number`of`common`shares
, outstanding.`It`is`based`on`the`historical`cost`of`the`assets.`Market`value`per`share`is
based`on`the`current`assessed`value`of`the`firm`in`the`marketplace`and`may`bear`little`r
elationship`to`original`cost.`Besides`the`disparity`between`book`and`market`value`caus
ed`by`the`historical`cost`approach,`other`contributing`factors`are`the`growth`prospects`
for`the`firm,`the`quality`of`management,`and`the`industry`outlook.`To`the`extent`these`
are`quite`negative`or`positive;`market`value`may`differ`widely`from`book`value.
2-3. Explain`how`depreciation`generates`actual`cash`flows`for`the`company.
The`only`way`depreciation`generates`cash`flows`for`the`company`is`by`serving`as`a`tax`
shield`against`reported`income.`This`non-
cash`deduction`may`provide`cash`flow`equal`to`the`tax`rate`times`the`depreciation`cha
rged.`This`much`in`taxes`will`be`saved,`while`no`cash`payments`occur.
2-4. What`is`the`difference`between`accumulated`depreciation`and`depreciation`expense?`
How`are`they`related?
Accumulated`depreciation`is`the`sum`of`all`past`and`present`depreciation`charges,`whil
e`depreciation`expense`is`the`current`year’s`charge.`They`are`related`in`that`the`sum`of`
all`prior`depreciation`expense`should`be`equal`to`accumulated`depreciation`(subject`to`
some`differential`related`to`asset
write-offs).
2-5. How`is`the`income`statement`related`to`the`balance`sheet?
The`earnings`(less`dividends)`reported`in`the`income`statement`is`transferred`to`the`
ownership`section`of`the`balance`sheet`as`retained`earnings.`Thus,`what`we`earn`in`
the`income`statement`becomes`part`of`the`ownership`interest`in`the`balance`sheet.
2-6. Comment`on`why`inflation`may`restrict`the`usefulness`of`the`balance`sheet`as`normall
y`presented.
The`balance`sheet`is`based`on`historical`costs.`When`prices`are`rising`rapidly,`historical`
cost`data`may`lose`much`of`their`meaning—particularly`for`plant`and`equipment`and
Foundations of Financial Management, 18th Edition by Stanley
Block, Geoffrey Hirt, Bartley Danielsen
Chapter`1
The`Goals`and`Functions`of`Financial`Management
Discussion`Questions
1-1 What`effect`did`the`recession`of`2007-2009`have`on`government`regulation?
It`was`greatly`increased.
1-2 What`advantages`does`a`sole`proprietorship`offer?`What`is`a`major`drawback`of`this`type`
of`organization?
A`sole`proprietorship`offers`the`advantage`of`simplicity`of`decision`making`and`low`organ
izational`and`operating`costs.`A`major`drawback`is`that`there`is`unlimited`liability`to`the`o
wner.
1-3 What`form`of`partnership`allows`some`of`the`investors`to`limit`their`liability? `Explain`
briefly.
A`limited`partnership`allows`some`of`the`partners`to`limit`their`liability.`Under`this`arrang
ement,`one`or`more`partners`are`designated`general`partners`and`have`unlimited`liability`fo
r`the`debts`of`the`firm;`other`partners`are`designated`limited`partners`and`are`liable`only`for
`their`initial`contribution.`The`limited`partners`are`normally`prohibited`from`being`active`in
`the`management`of`the`firm.
1-4 In`a`corporation,`what`group`has`the`ultimate`responsibility`for`protecting`and`managing`t
he`stockholders’`interests?
The`board`of`directors.
1-5 What`document`is`necessary`to`form`a`corporation?
The`articles`of`incorporation.
1-6 What`issue`does`agency`theory`examine?`Why`is`it`important`in`a`public`corporation`
rather`than`in`a`private`corporation?
, Agency`theory`examines`the`relationship`between`the`owners`of`the`firm`and`the`manager
s`of`the`firm.`In`privately`owned`firms,`management`and`the`owners`are`usually`the`same`p
eople.`Management`operates`the`firm`to`satisfy`its`own`goals,`needs,`financial`requirement
s`and`the`like.`As`a`company`moves`from`private`to`public`ownership,`management`now`r
epresents`all`owners.`This`places`management`in`the`agency`position`of`making`decisions`
in`the`best`interest`of`all`shareholders.
1-7 What`are`institutional`investors`important`in`today’s`business`world?
Because`institutional`investors`such`as`pension`funds`and`mutual`funds`own`a`large`percent
age`of`major`U.S.`companies,`they`are`having`more`to`say`about`the`way`publicly`owned`co
mpanies`are`managed.`As`a`group,`they`have`the`ability`to`vote`large`blocks`of`shares`for`th
e`election`of`a`board`of`directors,`which`is`supposed`to`run`the`company`in`an`efficient,`com
petitive`manner.`The`threat`of`being`able`to`replace`poor`performing`boards`of`directors`ma
kes`institutional`investors`quite`influential.`Since`these`institutions,`like`pension`funds`and`
mutual`funds,`represent`individual`workers`and`investors,`they`have`a`responsibility`to`see`t
hat`the`firm`is`managed`in`an`efficient`and`ethical`way.
1-8 Why`is`profit`maximization,`by`itself,`an`inappropriate`goal?`What`is`meant`by`the`goal`
of`maximization`of`shareholder`wealth?
The`problem`with`a`profit`maximization`goal`is`that`it`fails`to`take`account`of`risk,`the`timi
ng`of`the`benefits`is`not`considered,`and`profit`measurement`is`a`very`inexact`process.`The`
goal`of`shareholders’`wealth`maximization`implies`that`the`firm`will`attempt`to`achieve`th
e`highest`possible`total`valuation`in`the`marketplace.`It`is`the`one`overriding`objective`of`t
he`firm`and`should`influence`every`decision.
1-9 When`does`insider`trading`occur?`What`government`agency`is`responsible`for`protecting`
against`the`unethical`practice`of`insider`trading?
Insider`trading`occurs`when`anyone`with`non-
public`information`buys`or`sells`securities`to`take`advantage`of`that`private`information.`T
he`Securities`and`Exchange`Commission`is`responsible`for`protecting`markets`against`insi
der`trading.`In`the`past,`people`have`gone`to`jail`for`trading`on`non-
public`information.`This`has`included`company`officers,`investment`bankers,`printers`who
`have`information`before`it`is`published,`and`even`truck`drivers`who`deliver`business`maga
zines`and`read`positive`or`negative`articles`about`a`company`before`the`magazine`is`on`the`
newsstands`and`then`place`trades`or`have`friends`place`trades`based`on`that`information.`T
he`SEC`has`prosecuted`anyone`who`profits`from`inside`information.
1-10 In`terms`of`the`life`of`the`securities`offered,`what`is`the`difference`between`money`and`
capital`markets?
Money`markets`refer`to`those`markets`dealing`with`short-
term`securities`that`have`a`life`of`one`year`or`less.`Capital`markets`refer`to`securities`with`
a`life`of`more`than`one`year.
1-11 What`is`the`difference`between`a`primary`and`a`secondary`market?
, A`primary`market`refers`to`the`use`of`the`financial`markets`to`raise`new`funds`for`the`corp
oration.`After`the`securities`are`sold`to`the`public`(institutions`and`individuals),`they`trade`i
n`the`secondary`market`between`investors.`It`is`in`the`secondary`market`that`prices`are`cont
inually`changing`as`investors`buy`and`sell`securities`based`on`the`expectations`of`corporate
`prospects.
1-12 Assume`you`are`looking`at`many`companies`with`equal`risk.`Which`ones`will`have`the`
highest`stock`prices?
Given`companies`with`equal`risk,`those`companies`with`expectations`of`high`return`will`
have`higher`common`stock`prices`relative`to`those`companies`with`expectations`of`poor`
returns.
1-13 How`is`the`time`value`of`money`concept`related`to`the`valuation`of`stocks?
The`value`of`an`investment`that`is`expected`to`earn`money`in`the`future`can`be`calculated`u
sing`time-
value`of`money`principles.`Corporations`are`expected`to`pay`dividends`to`their`shareholder
s.`The`current`value`of`these`future`dividends`is`the`present`value.`The`present`value`of`a`st
ock’s`future`dividends`should`be`the`same`as`the`stock’s`current`price.
Chapter`2
Review`of`Accounting
Discussion`Questions
2-1. Discuss`some`financial`variables`that`affect`the`price-earnings`ratio.
The`price-
earnings`ratio`will`be`influenced`by`the`earnings`and`sales`growth`of`the`firm,`the`risk`
or`volatility`in`performance,`the`debt-
equity`structure`of`the`firm,`the`dividend`payment`policy,`the`quality`of`management,`
and`a`number`of`other`factors.`The`ratio`tends`to`be`future-
oriented,`and`the`more`positive`the`outlook,`the`higher`it`will`be.
2-2. What`is`the`difference`between`book`value`per`share`of`common`stock`and`market`val
ue`per`share?`Why`does`this`disparity`occur?
Book`value`per`share`is`arrived`at`by`taking`the`cost`of`the`assets`and`subtracting`out`li
abilities`and`preferred`stock`and`dividing`by`the`number`of`common`shares
, outstanding.`It`is`based`on`the`historical`cost`of`the`assets.`Market`value`per`share`is
based`on`the`current`assessed`value`of`the`firm`in`the`marketplace`and`may`bear`little`r
elationship`to`original`cost.`Besides`the`disparity`between`book`and`market`value`caus
ed`by`the`historical`cost`approach,`other`contributing`factors`are`the`growth`prospects`
for`the`firm,`the`quality`of`management,`and`the`industry`outlook.`To`the`extent`these`
are`quite`negative`or`positive;`market`value`may`differ`widely`from`book`value.
2-3. Explain`how`depreciation`generates`actual`cash`flows`for`the`company.
The`only`way`depreciation`generates`cash`flows`for`the`company`is`by`serving`as`a`tax`
shield`against`reported`income.`This`non-
cash`deduction`may`provide`cash`flow`equal`to`the`tax`rate`times`the`depreciation`cha
rged.`This`much`in`taxes`will`be`saved,`while`no`cash`payments`occur.
2-4. What`is`the`difference`between`accumulated`depreciation`and`depreciation`expense?`
How`are`they`related?
Accumulated`depreciation`is`the`sum`of`all`past`and`present`depreciation`charges,`whil
e`depreciation`expense`is`the`current`year’s`charge.`They`are`related`in`that`the`sum`of`
all`prior`depreciation`expense`should`be`equal`to`accumulated`depreciation`(subject`to`
some`differential`related`to`asset
write-offs).
2-5. How`is`the`income`statement`related`to`the`balance`sheet?
The`earnings`(less`dividends)`reported`in`the`income`statement`is`transferred`to`the`
ownership`section`of`the`balance`sheet`as`retained`earnings.`Thus,`what`we`earn`in`
the`income`statement`becomes`part`of`the`ownership`interest`in`the`balance`sheet.
2-6. Comment`on`why`inflation`may`restrict`the`usefulness`of`the`balance`sheet`as`normall
y`presented.
The`balance`sheet`is`based`on`historical`costs.`When`prices`are`rising`rapidly,`historical`
cost`data`may`lose`much`of`their`meaning—particularly`for`plant`and`equipment`and
