SOLUTIONS MANUAL
FUNDAMENTALS OF
CORPORATE FINANCE
TH
13 EDITION BY
ROSS, WESTERFIELD,
AND JORDAN
,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 Sharehold ers 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.
,TOPEXAMINER:2
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.
, CHAPTER 2 - 3
16. How Much Is Too Much? Who Is Worth More, Mark Parker Or Lebron James? The Simplest Answer Is
That There Is A Market For Executives Just As There Is For All Types Of Labor. Executive
Compensation Is The Price That Clears The Market. The Same Is True For Athletes And Performers.
Having Said That, One Aspect Of Executive Compensation Deserves Comment. A Primary Reason
Executive Compensation Has Grown So Dramatically Is That Companies Have Increasingly Moved To
Stock-Based Compensation. Such Movement Is Obviously Consistent With The Attempt To Better
Align Stockholder And Management Interests. In Recent Years, Stock Prices Have Soared, So
Management Has Cleaned Up. It Is Sometimes Argued That Much Of This Reward Is Due To Rising
Stock Prices In General, Not Managerial Performance. Perhaps In The Future, Executive
Compensation Will Be Designed To Reward Only Differential Performance, That Is, Stock Price
Increases In Excess Of General Market Increases.
CHAPTER 2
FINANCIAL STATEMENTS, TAXES, AND CASH FLOW
Answers To Concepts Review And Critical Thinking Questions
1. Liquidity Measures How Quickly And Easily An Asset Can Be Converted To Cash Without Significant
Loss In Value. It‗S Desirable For Firms To Have High Liquidity So That They Have A Large Factor Of
Safety In Meeting Short-Term Creditor Demands. However, Since Liquidity Also Has An Opportunity
Cost Associated With It—Namely That Higher Returns Can Generally Be Found By Investing The Cash
Into Productive Assets—Low Liquidity Levels Are Also Desirable To The Firm. It‗S Up To The Firm‗S
Financial Management Staff To Find A Reasonable Compromise Between These Opposing Needs.
2. The Recognition And Matching Principles In Financial Accounting Call For Revenues, And The Costs
Associated With Producing Those Revenues, To Be ―Booked ‖ When The Revenue Process Is
Essentially Complete, Not Necessarily When The Cash Is Collected Or Bills Are Paid . Note That This
Way Is Not Necessarily Correct; It‗S The Way Accountants Have Chosen To Do It.
3. Historical Costs Can Be Objectively And Precisely Measured Whereas Market Values Can Be Difficult
To Estimate, And Different Analysts Would Come Up With Different Numbers. Thus, There Is A Trade-
Off Between Relevance (Market Values) And Objectivity (Book Values).
4. Depreciation Is A Noncash Deduction That Reflects Adjustments Made In Asset Book Values In
Accordance With The Matching Principle In Financial Accounting. Interest Expense Is A Cash Outlay,
But It‗S A Financing Cost, Not An Operating Cost.
5. Market Values Can Never Be Negative. Imagine A Share Of Stock Selling For –$20. This Would Mean
That If You Placed An Order For 100 Shares, You Would Get The Stock Along With A Check For
$2,000. How Many Shares Do You Want To Buy? More Generally, Because Of Corporate And
Individual Bankruptcy Laws, Net Worth For A Person Or A Corporation Cannot Be Negative, Implying
That Liabilities Cannot Exceed Assets In Market Value.
FUNDAMENTALS OF
CORPORATE FINANCE
TH
13 EDITION BY
ROSS, WESTERFIELD,
AND JORDAN
,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 Sharehold ers 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.
,TOPEXAMINER:2
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.
, CHAPTER 2 - 3
16. How Much Is Too Much? Who Is Worth More, Mark Parker Or Lebron James? The Simplest Answer Is
That There Is A Market For Executives Just As There Is For All Types Of Labor. Executive
Compensation Is The Price That Clears The Market. The Same Is True For Athletes And Performers.
Having Said That, One Aspect Of Executive Compensation Deserves Comment. A Primary Reason
Executive Compensation Has Grown So Dramatically Is That Companies Have Increasingly Moved To
Stock-Based Compensation. Such Movement Is Obviously Consistent With The Attempt To Better
Align Stockholder And Management Interests. In Recent Years, Stock Prices Have Soared, So
Management Has Cleaned Up. It Is Sometimes Argued That Much Of This Reward Is Due To Rising
Stock Prices In General, Not Managerial Performance. Perhaps In The Future, Executive
Compensation Will Be Designed To Reward Only Differential Performance, That Is, Stock Price
Increases In Excess Of General Market Increases.
CHAPTER 2
FINANCIAL STATEMENTS, TAXES, AND CASH FLOW
Answers To Concepts Review And Critical Thinking Questions
1. Liquidity Measures How Quickly And Easily An Asset Can Be Converted To Cash Without Significant
Loss In Value. It‗S Desirable For Firms To Have High Liquidity So That They Have A Large Factor Of
Safety In Meeting Short-Term Creditor Demands. However, Since Liquidity Also Has An Opportunity
Cost Associated With It—Namely That Higher Returns Can Generally Be Found By Investing The Cash
Into Productive Assets—Low Liquidity Levels Are Also Desirable To The Firm. It‗S Up To The Firm‗S
Financial Management Staff To Find A Reasonable Compromise Between These Opposing Needs.
2. The Recognition And Matching Principles In Financial Accounting Call For Revenues, And The Costs
Associated With Producing Those Revenues, To Be ―Booked ‖ When The Revenue Process Is
Essentially Complete, Not Necessarily When The Cash Is Collected Or Bills Are Paid . Note That This
Way Is Not Necessarily Correct; It‗S The Way Accountants Have Chosen To Do It.
3. Historical Costs Can Be Objectively And Precisely Measured Whereas Market Values Can Be Difficult
To Estimate, And Different Analysts Would Come Up With Different Numbers. Thus, There Is A Trade-
Off Between Relevance (Market Values) And Objectivity (Book Values).
4. Depreciation Is A Noncash Deduction That Reflects Adjustments Made In Asset Book Values In
Accordance With The Matching Principle In Financial Accounting. Interest Expense Is A Cash Outlay,
But It‗S A Financing Cost, Not An Operating Cost.
5. Market Values Can Never Be Negative. Imagine A Share Of Stock Selling For –$20. This Would Mean
That If You Placed An Order For 100 Shares, You Would Get The Stock Along With A Check For
$2,000. How Many Shares Do You Want To Buy? More Generally, Because Of Corporate And
Individual Bankruptcy Laws, Net Worth For A Person Or A Corporation Cannot Be Negative, Implying
That Liabilities Cannot Exceed Assets In Market Value.
