Solution Manual
Corporate Finance
By Stephen Ross, Randolph Westerfield
13th Edition
,Chapter 1
Introduction To Corporate Finance
Answers To Concepts Review And Critical Thinking Questions
1. Capital Budgeting (Deciding Whether To Expand A Manufacturing Plant), Capital Structure
(Deciding Whether To Issue New Equity And Use The Proceeds To Retire Outstanding Debt), And
Working Capital Management (Modifying The Firm‘S Credit Collection Policy With Its Customers).
2. Disadvantages: Unlimited Liability, Limited Life, Difficulty In Transferring Ownership, Difficulty
In Raising Capital Funds. Some Advantages: Simpler, Less Regulation, The Owners Are Also The
Managers, Sometimes Personal Tax Rates Are Better Than Corporate Tax Rates.
3. The Primary Disadvantage Of The Corporate Form Is The Double Taxation To Shareholders Of
Distributed Earnings And Dividends. Some Advantages Include: Limited Liability, Ease Of
Transferability, Ability To Raise Capital, And Unlimited Life.
4. In Response To Sarbanes-Oxley, Small Firms Have Elected To Go Dark Because Of The Costs Of
Compliance. The Costs To Comply With Sarbox Can Be Several Million Dollars, Which Can Be A
Large Percentage Of A Small Firm‘S Profits. A Major Cost Of Going Dark Is Less Access To
Capital. Since The Firm Is No Longer Publicly Traded, It Can No Longer Raise Money In The
Public Market. Although The Company Will Still Have Access To Bank Loans And The Private
Equity Market, The Costs Associated With Raising Funds In These Markets Are Usually Higher
Than The Costs Of Raising Funds In The Public Market.
5. The Treasurer‘S Office And The Controller‘S Office Are The Two Primary Organizational Groups
That Report Directly To The Chief Financial Officer. The Controller‘S Office Handles Cost And
Financial Accounting, Tax Management, And Management Information Systems, While The
Treasurer‘S Office Is Responsible For Cash And Credit Management, Capital Budgeting, And
Financial Planning. Therefore, The Study Of Corporate Finance Is Concentrated Within The
Treasury Group‘S Functions.
6. To Maximize The Current Market Value (Share Price) Of The Equity Of The Firm (Whether It‘S
Publicly Traded Or Not).
7. In The Corporate Form Of Ownership, The Shareholders Are The Owners Of The Firm. The
Shareholders Elect The Directors Of The Corporation, Who In Turn Appoint The Firm‘S
Management. This Separation Of Ownership From Control In The Corporate Form Of Organization
Is What Causes Agency Problems To Exist. Management May Act In Its Own Or Someone Else‘S
Best Interests, Rather Than Those Of The Shareholders. If Such Events Occur, They May Contradict
The Goal Of Maximizing The Share Price Of The Equity Of The Firm.
8. A Primary Market Transaction.
,
, 9. In Auction Markets Like The Nyse, Brokers And Agents Meet At A Physical Location (The
Exchange) To Match Buyers And Sellers Of Assets. Dealer Markets Like Nasdaq Consist Of Dealers
Operating At Dispersed Locales Who Buy And Sell Assets Themselves, Communicating With Other
Dealers Either Electronically Or Literally Over-The-Counter.
10. Such Organizations Frequently Pursue Social Or Political Missions, So Many Different Goals Are
Conceivable. One Goal That Is Often Cited Is Revenue Minimization; That Is, Provide Whatever
Goods And Services Are Offered At The Lowest Possible Cost To Society. A Better Approach
Might Be To Observe That Even A Not-For-Profit Business Has Equity. Thus, One Answer Is That
The Appropriate Goal Is To Maximize The Value Of The Equity.
11. Presumably, The Current Stock Value Reflects The Risk, Timing, And Magnitude Of All Future
Cash Flows, Both Short-Term And Long-Term. If This Is Correct, Then The Statement Is False.
12. An Argument Can Be Made Either Way. At The One Extreme, We Could Argue That In A Market
Economy, All Of These Things Are Priced. There Is Thus An Optimal Level Of, For Example,
Ethical And/Or Illegal Behavior, And The Framework Of Stock Valuation Explicitly Includes These.
At The Other Extreme, We Could Argue That These Are Noneconomic Phenomena And Are Best
Handled Through The Political Process. A Classic (And Highly Relevant) Thought Question That
Illustrates This Debate Goes Something Like This: ―A Firm Has Estimated That The Cost Of
Improving The Safety Of One Of Its Products Is $30 Million. However, The Firm Believes That
Improving The Safety Of The Product Will Only Save $20 Million In Product Liability Claims.
What Should The Firm Do?‖
13. The Goal Will Be The Same, But The Best Course Of Action Toward That Goal May Be Different
Because Of Differing Social, Political, And Economic Institutions.
14. The Goal Of Management Should Be To Maximize The Share Price For The Current Shareholders.
If Management Believes That It Can Improve The Profitability Of The Firm So That The Share Price
Will Exceed $35, Then They Should Fight The Offer From The Outside Company. If Management
Believes That This Bidder Or Other Unidentified Bidders Will Actually Pay More Than $35 Per
Share To Acquire The Company, Then They Should Still Fight The Offer. However, If The Current
Management Cannot Increase The Value Of The Firm Beyond The Bid Price, And No Other Higher
Bids Come In, Then Management Is Not Acting In The Interests Of The Shareholders By Fighting
The Offer. Since Current Managers Often Lose Their Jobs When The Corporation Is Acquired,
Poorly Monitored Managers Have An Incentive To Fight Corporate Takeovers In Situations Such As
This.
15. We Would Expect Agency Problems To Be Less Severe In Countries With A Relatively Small
Percentage Of Individual Ownership. Fewer Individual Owners Should Reduce The Number Of
Diverse Opinions Concerning Corporate Goals. The High Percentage Of Institutional Ownership
Might Lead To A Higher Degree Of Agreement Between Owners And Managers On Decisions
Concerning Risky Projects. In Addition, Institutions May Be Better Able To Implement Effective
Monitoring Mechanisms On Managers Than Can Individual Owners, Based On The Institutions‘
Deeper Resources And Experiences With Their Own Management. The Increase In Institutional
Ownership Of Stock In The United States And The Growing Activism Of These Large Shareholder
Groups May Lead To A Reduction In Agency Problems For
U.S. Corporations And A More Efficient Market For Corporate Control.
Corporate Finance
By Stephen Ross, Randolph Westerfield
13th Edition
,Chapter 1
Introduction To Corporate Finance
Answers To Concepts Review And Critical Thinking Questions
1. Capital Budgeting (Deciding Whether To Expand A Manufacturing Plant), Capital Structure
(Deciding Whether To Issue New Equity And Use The Proceeds To Retire Outstanding Debt), And
Working Capital Management (Modifying The Firm‘S Credit Collection Policy With Its Customers).
2. Disadvantages: Unlimited Liability, Limited Life, Difficulty In Transferring Ownership, Difficulty
In Raising Capital Funds. Some Advantages: Simpler, Less Regulation, The Owners Are Also The
Managers, Sometimes Personal Tax Rates Are Better Than Corporate Tax Rates.
3. The Primary Disadvantage Of The Corporate Form Is The Double Taxation To Shareholders Of
Distributed Earnings And Dividends. Some Advantages Include: Limited Liability, Ease Of
Transferability, Ability To Raise Capital, And Unlimited Life.
4. In Response To Sarbanes-Oxley, Small Firms Have Elected To Go Dark Because Of The Costs Of
Compliance. The Costs To Comply With Sarbox Can Be Several Million Dollars, Which Can Be A
Large Percentage Of A Small Firm‘S Profits. A Major Cost Of Going Dark Is Less Access To
Capital. Since The Firm Is No Longer Publicly Traded, It Can No Longer Raise Money In The
Public Market. Although The Company Will Still Have Access To Bank Loans And The Private
Equity Market, The Costs Associated With Raising Funds In These Markets Are Usually Higher
Than The Costs Of Raising Funds In The Public Market.
5. The Treasurer‘S Office And The Controller‘S Office Are The Two Primary Organizational Groups
That Report Directly To The Chief Financial Officer. The Controller‘S Office Handles Cost And
Financial Accounting, Tax Management, And Management Information Systems, While The
Treasurer‘S Office Is Responsible For Cash And Credit Management, Capital Budgeting, And
Financial Planning. Therefore, The Study Of Corporate Finance Is Concentrated Within The
Treasury Group‘S Functions.
6. To Maximize The Current Market Value (Share Price) Of The Equity Of The Firm (Whether It‘S
Publicly Traded Or Not).
7. In The Corporate Form Of Ownership, The Shareholders Are The Owners Of The Firm. The
Shareholders Elect The Directors Of The Corporation, Who In Turn Appoint The Firm‘S
Management. This Separation Of Ownership From Control In The Corporate Form Of Organization
Is What Causes Agency Problems To Exist. Management May Act In Its Own Or Someone Else‘S
Best Interests, Rather Than Those Of The Shareholders. If Such Events Occur, They May Contradict
The Goal Of Maximizing The Share Price Of The Equity Of The Firm.
8. A Primary Market Transaction.
,
, 9. In Auction Markets Like The Nyse, Brokers And Agents Meet At A Physical Location (The
Exchange) To Match Buyers And Sellers Of Assets. Dealer Markets Like Nasdaq Consist Of Dealers
Operating At Dispersed Locales Who Buy And Sell Assets Themselves, Communicating With Other
Dealers Either Electronically Or Literally Over-The-Counter.
10. Such Organizations Frequently Pursue Social Or Political Missions, So Many Different Goals Are
Conceivable. One Goal That Is Often Cited Is Revenue Minimization; That Is, Provide Whatever
Goods And Services Are Offered At The Lowest Possible Cost To Society. A Better Approach
Might Be To Observe That Even A Not-For-Profit Business Has Equity. Thus, One Answer Is That
The Appropriate Goal Is To Maximize The Value Of The Equity.
11. Presumably, The Current Stock Value Reflects The Risk, Timing, And Magnitude Of All Future
Cash Flows, Both Short-Term And Long-Term. If This Is Correct, Then The Statement Is False.
12. An Argument Can Be Made Either Way. At The One Extreme, We Could Argue That In A Market
Economy, All Of These Things Are Priced. There Is Thus An Optimal Level Of, For Example,
Ethical And/Or Illegal Behavior, And The Framework Of Stock Valuation Explicitly Includes These.
At The Other Extreme, We Could Argue That These Are Noneconomic Phenomena And Are Best
Handled Through The Political Process. A Classic (And Highly Relevant) Thought Question That
Illustrates This Debate Goes Something Like This: ―A Firm Has Estimated That The Cost Of
Improving The Safety Of One Of Its Products Is $30 Million. However, The Firm Believes That
Improving The Safety Of The Product Will Only Save $20 Million In Product Liability Claims.
What Should The Firm Do?‖
13. The Goal Will Be The Same, But The Best Course Of Action Toward That Goal May Be Different
Because Of Differing Social, Political, And Economic Institutions.
14. The Goal Of Management Should Be To Maximize The Share Price For The Current Shareholders.
If Management Believes That It Can Improve The Profitability Of The Firm So That The Share Price
Will Exceed $35, Then They Should Fight The Offer From The Outside Company. If Management
Believes That This Bidder Or Other Unidentified Bidders Will Actually Pay More Than $35 Per
Share To Acquire The Company, Then They Should Still Fight The Offer. However, If The Current
Management Cannot Increase The Value Of The Firm Beyond The Bid Price, And No Other Higher
Bids Come In, Then Management Is Not Acting In The Interests Of The Shareholders By Fighting
The Offer. Since Current Managers Often Lose Their Jobs When The Corporation Is Acquired,
Poorly Monitored Managers Have An Incentive To Fight Corporate Takeovers In Situations Such As
This.
15. We Would Expect Agency Problems To Be Less Severe In Countries With A Relatively Small
Percentage Of Individual Ownership. Fewer Individual Owners Should Reduce The Number Of
Diverse Opinions Concerning Corporate Goals. The High Percentage Of Institutional Ownership
Might Lead To A Higher Degree Of Agreement Between Owners And Managers On Decisions
Concerning Risky Projects. In Addition, Institutions May Be Better Able To Implement Effective
Monitoring Mechanisms On Managers Than Can Individual Owners, Based On The Institutions‘
Deeper Resources And Experiences With Their Own Management. The Increase In Institutional
Ownership Of Stock In The United States And The Growing Activism Of These Large Shareholder
Groups May Lead To A Reduction In Agency Problems For
U.S. Corporations And A More Efficient Market For Corporate Control.
