Solution Manual
Principles Of Corporate Finance
By Richard Brealey, Stewart Myers,
, 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
Principles Of Corporate Finance
By Richard Brealey, Stewart Myers,
, 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
