,
,CHAPTER 1 g
INTRODUCTION TO CORPORATE g g
FINANCE
g
Answers gto gConcepts gReview gand gCritical gThinking gQuestions
1. Capital gbudgeting g(deciding gwhether gto gexpand ga gmanufacturing gplant), gcapital gstructure g(deciding
gwhether gto gissue gnew gequity gand guse gthe gproceeds gto gretire goutstanding gdebt), gand gworking gcapital
gmanagement g(modifying gthe gfirm‗s gcredit gcollection gpolicy gwith gits gcustomers).
2. Disadvantages: gunlimited gliability, glimited glife, gdifficulty gin gtransferring gownership, gdifficulty gin
graising gcapital gfunds. gSome gadvantages: gsimpler, gless gregulation, gthe gowners gare galso gthe
gmanagers, gsometimes gpersonal gtax grates gare gbetter gthan gcorporate gtax grates.
3. The gprimary gdisadvantage gof gthe gcorporate gform gis gthe gdouble gtaxation gto gshareholders gof
gdistributed gearnings gand gdividends. gSome gadvantages ginclude: glimited gliability, gease gof
gtransferability, gability gto graise gcapital, gand gunlimited glife.
4. In gresponse gto gSarbanes-Oxley, gsmall gfirms ghave gelected gto ggo gdark gbecause gof gthe gcosts gof
gcompliance. gThe gcosts gto gcomply gwith gSarbox gcan gbe gseveral gmillion gdollars, gwhich gcan gbe ga
glarge gpercentage gof ga gsmall gfirm‗s gprofits. gA gmajor gcost gof ggoing gdark gis gless gaccess gto gcapital.
gSince gthe gfirm gis gno glonger gpublicly gtraded, git gcan gno glonger graise gmoney gin gthe gpublic gmarket.
gAlthough gthe gcompany gwill gstill ghave gaccess gto gbank gloans gand gthe gprivate gequity gmarket, gthe
gcosts gassociated gwith graising gfunds gin gthese gmarkets gare gusually ghigher gthan gthe gcosts gof graising
gfunds gin gthe gpublic gmarket.
5. The gtreasurer‗s goffice gand gthe gcontroller‗s goffice gare gthe gtwo gprimary gorganizational ggroups gthat
g report gdirectly gto gthe gchief gfinancial gofficer. gThe gcontroller‗s goffice ghandles gcost gand gfinancial
gaccounting, gtax gmanagement, gand gmanagement ginformation gsystems, gwhile gthe gtreasurer‗s goffice gis
gresponsible gfor gcash gand gcredit gmanagement, gcapital gbudgeting, gand gfinancial gplanning. gTherefore,
g the gstudy gof gcorporate gfinance gis gconcentrated gwithin gthe gtreasury ggroup‗s gfunctions.
6. To gmaximize gthe gcurrent gmarket gvalue g(share gprice) gof gthe gequity gof gthe gfirm g(whether git‗s
gpublicly gtraded gor gnot).
7. In gthe gcorporate gform gof gownership, gthe gshareholders gare gthe gowners gof gthe gfirm. gThe gshareholders
gelect gthe gdirectors gof gthe gcorporation, gwho gin gturn gappoint gthe gfirm‗s gmanagement. gThis gseparation
gof gownership gfrom gcontrol gin gthe gcorporate gform gof gorganization gis gwhat gcauses gagency gproblems
gto gexist. gManagement gmay gact gin gits gown gor gsomeone gelse‗s gbest ginterests, grather gthan gthose gof gthe
gshareholders. gIf gsuch gevents goccur, gthey gmay gcontradict gthe ggoal gof gmaximizing gthe gshare gprice gof
gthe gequity gof gthe gfirm.
8. A gprimary gmarket gtransaction.
, 2 g SOLUTIONS gMANUAL
9. In gauction gmarkets glike gthe gNYSE, gbrokers gand gagents gmeet gat ga gphysical glocation g(the gexchange)
gto gmatch gbuyers gand gsellers gof gassets. gDealer gmarkets glike gNASDAQ gconsist gof gdealers goperating
gat gdispersed glocales gwho gbuy gand gsell gassets gthemselves, gcommunicating gwith gother gdealers geither
gelectronically gor gliterally gover-the-counter.
10. Such gorganizations gfrequently gpursue gsocial gor gpolitical gmissions, gso gmany gdifferent ggoals gare
gconceivable. gOne ggoal gthat gis goften gcited gis grevenue gminimization; gthat gis, gprovide gwhatever ggoods
g and gservices gare goffered gat gthe glowest gpossible gcost gto gsociety. gA gbetter gapproach gmight gbe gto
gobserve gthat geven ga gnot-for-profit gbusiness ghas gequity. gThus, gone ganswer gis gthat gthe gappropriate
ggoal gis gto gmaximize gthe gvalue gof gthe gequity.
11. Presumably, gthe gcurrent gstock gvalue greflects gthe grisk, gtiming, gand gmagnitude gof gall gfuture gcash
gflows, gboth gshort-term gand glong-term. gIf gthis gis gcorrect, gthen gthe gstatement gis gfalse.
12. An gargument gcan gbe gmade geither gway. gAt gthe gone gextreme, gwe gcould gargue gthat gin ga gmarket
geconomy, gall gof gthese gthings gare gpriced. gThere gis gthus gan goptimal glevel gof, gfor gexample, gethical
gand/or gillegal gbehavior, gand gthe gframework gof gstock gvaluation gexplicitly gincludes gthese. gAt gthe
gother gextreme, gwe gcould gargue gthat gthese gare gnoneconomic gphenomena gand gare gbest ghandled
gthrough gthe gpolitical gprocess. gA gclassic g(and ghighly grelevant) gthought gquestion gthat gillustrates gthis
gdebate ggoes gsomething glike gthis: g―A gfirm ghas gestimated gthat gthe gcost gof gimproving gthe gsafety gof
gone gof gits gproducts gis g$30 gmillion. gHowever, gthe gfirm gbelieves gthat gimproving gthe gsafety gof gthe
gproduct gwill gonly gsave g$20 gmillion gin gproduct gliability gclaims. gWhat gshould gthe gfirm gdo?‖
13. The ggoal gwill gbe gthe gsame, gbut gthe gbest gcourse gof gaction gtoward gthat ggoal gmay gbe gdifferent
gbecause gof gdiffering gsocial, gpolitical, gand geconomic ginstitutions.
14. The ggoal gof gmanagement gshould gbe gto gmaximize gthe gshare gprice gfor gthe gcurrent gshareholders. gIf
gmanagement gbelieves gthat git gcan gimprove gthe gprofitability gof gthe gfirm gso gthat gthe gshare gprice gwill
gexceed g$35, gthen gthey gshould gfight gthe goffer gfrom gthe goutside gcompany. gIf gmanagement gbelieves
gthat gthis gbidder gor gother gunidentified gbidders gwill gactually gpay gmore gthan g$35 gper gshare gto gacquire
gthe gcompany, gthen gthey gshould gstill gfight gthe goffer. gHowever, gif gthe gcurrent gmanagement gcannot
gincrease gthe gvalue gof gthe gfirm gbeyond gthe gbid gprice, gand gno gother ghigher gbids gcome gin, gthen
gmanagement gis gnot gacting gin gthe ginterests gof gthe gshareholders gby gfighting gthe goffer. gSince gcurrent
gmanagers goften glose gtheir gjobs gwhen gthe gcorporation gis gacquired, gpoorly gmonitored gmanagers ghave
gan gincentive gto gfight gcorporate gtakeovers gin gsituations gsuch gas gthis.
15. We gwould gexpect gagency gproblems gto gbe gless gsevere gin gcountries gwith ga grelatively gsmall
gpercentage g of gindividual gownership. gFewer gindividual gowners gshould greduce gthe gnumber gof
gdiverse gopinions gconcerning gcorporate ggoals. gThe ghigh gpercentage gof ginstitutional gownership
gmight glead gto ga ghigher gdegree gof gagreement gbetween gowners gand gmanagers gon gdecisions
gconcerning grisky gprojects. gIn gaddition, ginstitutions gmay gbe gbetter gable gto gimplement geffective
gmonitoring gmechanisms gon gmanagers gthan gcan gindividual gowners, gbased gon gthe ginstitutions‗
gdeeper gresources gand gexperiences gwith gtheir gown gmanagement. gThe gincrease gin ginstitutional
gownership gof gstock gin gthe gUnited gStates gand gthe ggrowing gactivism gof gthese glarge gshareholder
ggroups gmay glead gto ga greduction gin gagency gproblems gfor
U.S. gcorporations gand ga gmore gefficient gmarket gfor gcorporate gcontrol.
,CHAPTER 1 g
INTRODUCTION TO CORPORATE g g
FINANCE
g
Answers gto gConcepts gReview gand gCritical gThinking gQuestions
1. Capital gbudgeting g(deciding gwhether gto gexpand ga gmanufacturing gplant), gcapital gstructure g(deciding
gwhether gto gissue gnew gequity gand guse gthe gproceeds gto gretire goutstanding gdebt), gand gworking gcapital
gmanagement g(modifying gthe gfirm‗s gcredit gcollection gpolicy gwith gits gcustomers).
2. Disadvantages: gunlimited gliability, glimited glife, gdifficulty gin gtransferring gownership, gdifficulty gin
graising gcapital gfunds. gSome gadvantages: gsimpler, gless gregulation, gthe gowners gare galso gthe
gmanagers, gsometimes gpersonal gtax grates gare gbetter gthan gcorporate gtax grates.
3. The gprimary gdisadvantage gof gthe gcorporate gform gis gthe gdouble gtaxation gto gshareholders gof
gdistributed gearnings gand gdividends. gSome gadvantages ginclude: glimited gliability, gease gof
gtransferability, gability gto graise gcapital, gand gunlimited glife.
4. In gresponse gto gSarbanes-Oxley, gsmall gfirms ghave gelected gto ggo gdark gbecause gof gthe gcosts gof
gcompliance. gThe gcosts gto gcomply gwith gSarbox gcan gbe gseveral gmillion gdollars, gwhich gcan gbe ga
glarge gpercentage gof ga gsmall gfirm‗s gprofits. gA gmajor gcost gof ggoing gdark gis gless gaccess gto gcapital.
gSince gthe gfirm gis gno glonger gpublicly gtraded, git gcan gno glonger graise gmoney gin gthe gpublic gmarket.
gAlthough gthe gcompany gwill gstill ghave gaccess gto gbank gloans gand gthe gprivate gequity gmarket, gthe
gcosts gassociated gwith graising gfunds gin gthese gmarkets gare gusually ghigher gthan gthe gcosts gof graising
gfunds gin gthe gpublic gmarket.
5. The gtreasurer‗s goffice gand gthe gcontroller‗s goffice gare gthe gtwo gprimary gorganizational ggroups gthat
g report gdirectly gto gthe gchief gfinancial gofficer. gThe gcontroller‗s goffice ghandles gcost gand gfinancial
gaccounting, gtax gmanagement, gand gmanagement ginformation gsystems, gwhile gthe gtreasurer‗s goffice gis
gresponsible gfor gcash gand gcredit gmanagement, gcapital gbudgeting, gand gfinancial gplanning. gTherefore,
g the gstudy gof gcorporate gfinance gis gconcentrated gwithin gthe gtreasury ggroup‗s gfunctions.
6. To gmaximize gthe gcurrent gmarket gvalue g(share gprice) gof gthe gequity gof gthe gfirm g(whether git‗s
gpublicly gtraded gor gnot).
7. In gthe gcorporate gform gof gownership, gthe gshareholders gare gthe gowners gof gthe gfirm. gThe gshareholders
gelect gthe gdirectors gof gthe gcorporation, gwho gin gturn gappoint gthe gfirm‗s gmanagement. gThis gseparation
gof gownership gfrom gcontrol gin gthe gcorporate gform gof gorganization gis gwhat gcauses gagency gproblems
gto gexist. gManagement gmay gact gin gits gown gor gsomeone gelse‗s gbest ginterests, grather gthan gthose gof gthe
gshareholders. gIf gsuch gevents goccur, gthey gmay gcontradict gthe ggoal gof gmaximizing gthe gshare gprice gof
gthe gequity gof gthe gfirm.
8. A gprimary gmarket gtransaction.
, 2 g SOLUTIONS gMANUAL
9. In gauction gmarkets glike gthe gNYSE, gbrokers gand gagents gmeet gat ga gphysical glocation g(the gexchange)
gto gmatch gbuyers gand gsellers gof gassets. gDealer gmarkets glike gNASDAQ gconsist gof gdealers goperating
gat gdispersed glocales gwho gbuy gand gsell gassets gthemselves, gcommunicating gwith gother gdealers geither
gelectronically gor gliterally gover-the-counter.
10. Such gorganizations gfrequently gpursue gsocial gor gpolitical gmissions, gso gmany gdifferent ggoals gare
gconceivable. gOne ggoal gthat gis goften gcited gis grevenue gminimization; gthat gis, gprovide gwhatever ggoods
g and gservices gare goffered gat gthe glowest gpossible gcost gto gsociety. gA gbetter gapproach gmight gbe gto
gobserve gthat geven ga gnot-for-profit gbusiness ghas gequity. gThus, gone ganswer gis gthat gthe gappropriate
ggoal gis gto gmaximize gthe gvalue gof gthe gequity.
11. Presumably, gthe gcurrent gstock gvalue greflects gthe grisk, gtiming, gand gmagnitude gof gall gfuture gcash
gflows, gboth gshort-term gand glong-term. gIf gthis gis gcorrect, gthen gthe gstatement gis gfalse.
12. An gargument gcan gbe gmade geither gway. gAt gthe gone gextreme, gwe gcould gargue gthat gin ga gmarket
geconomy, gall gof gthese gthings gare gpriced. gThere gis gthus gan goptimal glevel gof, gfor gexample, gethical
gand/or gillegal gbehavior, gand gthe gframework gof gstock gvaluation gexplicitly gincludes gthese. gAt gthe
gother gextreme, gwe gcould gargue gthat gthese gare gnoneconomic gphenomena gand gare gbest ghandled
gthrough gthe gpolitical gprocess. gA gclassic g(and ghighly grelevant) gthought gquestion gthat gillustrates gthis
gdebate ggoes gsomething glike gthis: g―A gfirm ghas gestimated gthat gthe gcost gof gimproving gthe gsafety gof
gone gof gits gproducts gis g$30 gmillion. gHowever, gthe gfirm gbelieves gthat gimproving gthe gsafety gof gthe
gproduct gwill gonly gsave g$20 gmillion gin gproduct gliability gclaims. gWhat gshould gthe gfirm gdo?‖
13. The ggoal gwill gbe gthe gsame, gbut gthe gbest gcourse gof gaction gtoward gthat ggoal gmay gbe gdifferent
gbecause gof gdiffering gsocial, gpolitical, gand geconomic ginstitutions.
14. The ggoal gof gmanagement gshould gbe gto gmaximize gthe gshare gprice gfor gthe gcurrent gshareholders. gIf
gmanagement gbelieves gthat git gcan gimprove gthe gprofitability gof gthe gfirm gso gthat gthe gshare gprice gwill
gexceed g$35, gthen gthey gshould gfight gthe goffer gfrom gthe goutside gcompany. gIf gmanagement gbelieves
gthat gthis gbidder gor gother gunidentified gbidders gwill gactually gpay gmore gthan g$35 gper gshare gto gacquire
gthe gcompany, gthen gthey gshould gstill gfight gthe goffer. gHowever, gif gthe gcurrent gmanagement gcannot
gincrease gthe gvalue gof gthe gfirm gbeyond gthe gbid gprice, gand gno gother ghigher gbids gcome gin, gthen
gmanagement gis gnot gacting gin gthe ginterests gof gthe gshareholders gby gfighting gthe goffer. gSince gcurrent
gmanagers goften glose gtheir gjobs gwhen gthe gcorporation gis gacquired, gpoorly gmonitored gmanagers ghave
gan gincentive gto gfight gcorporate gtakeovers gin gsituations gsuch gas gthis.
15. We gwould gexpect gagency gproblems gto gbe gless gsevere gin gcountries gwith ga grelatively gsmall
gpercentage g of gindividual gownership. gFewer gindividual gowners gshould greduce gthe gnumber gof
gdiverse gopinions gconcerning gcorporate ggoals. gThe ghigh gpercentage gof ginstitutional gownership
gmight glead gto ga ghigher gdegree gof gagreement gbetween gowners gand gmanagers gon gdecisions
gconcerning grisky gprojects. gIn gaddition, ginstitutions gmay gbe gbetter gable gto gimplement geffective
gmonitoring gmechanisms gon gmanagers gthan gcan gindividual gowners, gbased gon gthe ginstitutions‗
gdeeper gresources gand gexperiences gwith gtheir gown gmanagement. gThe gincrease gin ginstitutional
gownership gof gstock gin gthe gUnited gStates gand gthe ggrowing gactivism gof gthese glarge gshareholder
ggroups gmay glead gto ga greduction gin gagency gproblems gfor
U.S. gcorporations gand ga gmore gefficient gmarket gfor gcorporate gcontrol.
