Solutions Manual Fundamentals of Corporate Finance
13th Edition Ross, Westerfield, and Jordan
Chapters 1 - 27
,CHAPTER 1: Introduction to Corporate Finance
CHAPTER 2: Financial Statements, Taxes, And Cash Flow
CHAPTER 3: Working with Financial Statements
CHAPTER 4: Long-Term Financial Planning and Growth
CHAPTER 5: Introduction to Valuation: The Time Value of Money
CHAPTER 6: Discounted Cash Flow Valuation
CHAPTER 7: Interest Rates and Bond Valuation
CHAPTER 8: Stock Valuation
CHAPTER 9: Net Present Value and Other Investment Criteria
CHAPTER 10: Making Capital Investment Decisions
CHAPTER 11: Project Analysis and Evaluation
CHAPTER 12: Some Lessons from Capital Market History
CHAPTER 13: Return, Risk, And the Security Market Line
CHAPTER 14: Cost of Capital
CHAPTER 15: Raising Capital
CHAPTER 16: Financial Leverage and Capital Structure Policy
CHAPTER 17: Dividends and Payout Policy
CHAPTER 18: Short-Term Finance and Planning
CHAPTER 19: Cash and Liquidity Management
CHAPTER 20: Credit and Inventory Management
CHAPTER 21: International Corporate Finance
CHAPTER 22: Behavioral Finance: Implications for Financial Manage
CHAPTER 23: Enterprise Risk Management
CHAPTER 24:Options and Corporate Finance
CHAPTER 25: Option Valuation
CHAPTER 26: Mergers and Acquisitions
CHAPTER 27: Leasing
,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, hard to raise
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 ear
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
nings and dividends. Some advantages include: limited liability, ease of transferability, ability to raise c
1 1 1 1 1 1 1 1 1 1 1 1 1 1
apital, unlimited life, and so forth.
1 1 1 1 1
4. In response to Sarbanes-
1 1 1
Oxley, small firms have elected to go dark because of the costs of compliance. The costs to comply wit
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
h Sarbox can be several million dollars, which can be a large percentage of a small firms profits. A ma
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
jor cost of going dark is less access to capital. Since thefirm is no longer publicly traded, it can no lon
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
ger raise money in the public market. Although the company will still have access to bank loans and the
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
private equity market, the costs associated with raising funds in these markets are usually higher than th
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
e costs of raising funds in the public market.
1 1 1 1 1 1 1 1
5. The treasurer‘s office and the controller‘s office are the two primary organizational groups thatre
1 1 1 1 1 1 1 1 1 1 1 1 1 1
port directly to the chief financial officer. The controller‘s office handles cost and financialaccounting,
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
tax management, and management information systems, while the treasurer‘s office is responsible for
1 1 1 1 1 1 1 1 1 1 1 1 1
cash and credit management, capital budgeting, and financial planning. Therefore,the study of corpo
1 1 1 1 1 1 1 1 1 1 1 1 1
rate finance is concentrated within the treasury group‘s functions.
1 1 1 1 1 1 1 1
6. To maximize the current market value (share price) of the equity of the firm (whether it‘s publicly-
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
traded or not).
1 1 1
7. In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders elect t
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
he directors of the corporation, who in turn appoint the firm‘s management. This separation of ownersh
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
ip from control in the corporate form of organization is what causes agency problems to exist. Manage
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
ment may act in its own or someone else‘s best interests, rather than those of the shareholders. If such e
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
vents occur, they may contradict the goal of maximizing the share price of the equity of the firm.
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
8. A primary market transaction.
1 1 1
, B-2 SOLUTIONS
1
9. In auction markets like the NYSE, brokers and agents meet at a physical location (the exchange) to mat
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
ch buyers and sellers of assets. Dealer markets like NASDAQ consist of dealers operating at dispersed l
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
ocales who buy and sell assets themselves, communicating with other dealers either electronically or lit
1 1 1 1 1 1 1 1 1 1 1 1 1 1
erally over-the-counter. 1
10. Such organizations frequently pursue social or political missions, so many different goals are conceiva
1 1 1 1 1 1 1 1 1 1 1 1 1
ble. One goal that is often cited is revenue minimization; i.e., provide whatever goods and services are o
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
ffered at the lowest possible cost to society. A better approach might be to observe that even a not-for-
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
profit business has equity. Thus, one answer is that the appropriate goal is to maximize the value of the
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
equity.
11. Presumably, the current stock value reflects the risk, timing, and magnitude of all future cash flows, bot
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
h short-term and long-term. If this is correct, then the statement is false.
1 1 1 1 1 1 1 1 1 1 1 1
12. An argument can be made either way. At the one extreme, we could argue that in a market economy,all
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
of these things are priced. There is thus an optimal level of, for example, ethical and/or illegal behavior,
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
and the framework of stock valuation explicitly includes these. At the other extreme, we could argue th
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
at these are non-
1 1 1
economic phenomena and are best handled through the political process. A classic (and highly relevant
1 1 1 1 1 1 1 1 1 1 1 1 1 1
) thought question that illustrates this debate goes something like this: ―A firm has estimated that the co
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
st of improving the safety of one of its products is $30 million. However, the firm believes that improvi
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
ng the safety of the product will only save $20 million in product liability claims. What should the firm
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
do?‖
13. The goal will be the same, but the best course of action toward that goal may be different because of diff
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
ering social, political, and economic institutions.
1 1 1 1 1
14. The goal of management should be to maximize the share price for the current shareholders. If manage
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
ment believes that it can improve the profitability of the firm so that the share price will exceed $35, the
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
n they should fight the offer from the outside company. If management believes that this bidder or other
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
unidentified bidders will actually pay more than $35 per share to acquire the company, then they shoul
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
d still fight the offer. However, if the current management cannot increase the value of the firm beyond
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
the bid price, and no other higher bids come in, then management is not acting in the interests of the sha
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
reholders by fighting the offer. Since current managers often lose their jobs when the corporation is acq
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
uired, poorly monitored managers have an incentive to fight corporate takeovers in situations such as th
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
is.
15. We would expect agency problems to be less severe in other countries, primarily due to the relativelys
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
mall percentage of individual ownership. Fewer individual owners should reduce the number of diverse
1 1 1 1 1 1 1 1 1 1 1 1 1
opinions concerning corporate goals. The high percentage of institutional ownership might lead to a hi
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
gher degree of agreement between owners and managers on decisions concerning risky projects. In add
1 1 1 1 1 1 1 1 1 1 1 1 1 1
ition, institutions may be better able to implement effective monitoring mechanisms on managers than
1 1 1 1 1 1 1 1 1 1 1 1 1 1
can individual owners, based on the institutions‘ deeper resources and experiences with their own mana
1 1 1 1 1 1 1 1 1 1 1 1 1 1
gement. The increase in institutional ownership of stock in the United States andthe growing activism o
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
f these large shareholder groups may lead to a reduction in agency problems for U.S. corporations and a
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
more efficient market for corporate control.
1 1 1 1 1 1
13th Edition Ross, Westerfield, and Jordan
Chapters 1 - 27
,CHAPTER 1: Introduction to Corporate Finance
CHAPTER 2: Financial Statements, Taxes, And Cash Flow
CHAPTER 3: Working with Financial Statements
CHAPTER 4: Long-Term Financial Planning and Growth
CHAPTER 5: Introduction to Valuation: The Time Value of Money
CHAPTER 6: Discounted Cash Flow Valuation
CHAPTER 7: Interest Rates and Bond Valuation
CHAPTER 8: Stock Valuation
CHAPTER 9: Net Present Value and Other Investment Criteria
CHAPTER 10: Making Capital Investment Decisions
CHAPTER 11: Project Analysis and Evaluation
CHAPTER 12: Some Lessons from Capital Market History
CHAPTER 13: Return, Risk, And the Security Market Line
CHAPTER 14: Cost of Capital
CHAPTER 15: Raising Capital
CHAPTER 16: Financial Leverage and Capital Structure Policy
CHAPTER 17: Dividends and Payout Policy
CHAPTER 18: Short-Term Finance and Planning
CHAPTER 19: Cash and Liquidity Management
CHAPTER 20: Credit and Inventory Management
CHAPTER 21: International Corporate Finance
CHAPTER 22: Behavioral Finance: Implications for Financial Manage
CHAPTER 23: Enterprise Risk Management
CHAPTER 24:Options and Corporate Finance
CHAPTER 25: Option Valuation
CHAPTER 26: Mergers and Acquisitions
CHAPTER 27: Leasing
,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, hard to raise
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 ear
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
nings and dividends. Some advantages include: limited liability, ease of transferability, ability to raise c
1 1 1 1 1 1 1 1 1 1 1 1 1 1
apital, unlimited life, and so forth.
1 1 1 1 1
4. In response to Sarbanes-
1 1 1
Oxley, small firms have elected to go dark because of the costs of compliance. The costs to comply wit
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
h Sarbox can be several million dollars, which can be a large percentage of a small firms profits. A ma
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
jor cost of going dark is less access to capital. Since thefirm is no longer publicly traded, it can no lon
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
ger raise money in the public market. Although the company will still have access to bank loans and the
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
private equity market, the costs associated with raising funds in these markets are usually higher than th
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
e costs of raising funds in the public market.
1 1 1 1 1 1 1 1
5. The treasurer‘s office and the controller‘s office are the two primary organizational groups thatre
1 1 1 1 1 1 1 1 1 1 1 1 1 1
port directly to the chief financial officer. The controller‘s office handles cost and financialaccounting,
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
tax management, and management information systems, while the treasurer‘s office is responsible for
1 1 1 1 1 1 1 1 1 1 1 1 1
cash and credit management, capital budgeting, and financial planning. Therefore,the study of corpo
1 1 1 1 1 1 1 1 1 1 1 1 1
rate finance is concentrated within the treasury group‘s functions.
1 1 1 1 1 1 1 1
6. To maximize the current market value (share price) of the equity of the firm (whether it‘s publicly-
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
traded or not).
1 1 1
7. In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders elect t
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
he directors of the corporation, who in turn appoint the firm‘s management. This separation of ownersh
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
ip from control in the corporate form of organization is what causes agency problems to exist. Manage
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
ment may act in its own or someone else‘s best interests, rather than those of the shareholders. If such e
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
vents occur, they may contradict the goal of maximizing the share price of the equity of the firm.
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
8. A primary market transaction.
1 1 1
, B-2 SOLUTIONS
1
9. In auction markets like the NYSE, brokers and agents meet at a physical location (the exchange) to mat
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
ch buyers and sellers of assets. Dealer markets like NASDAQ consist of dealers operating at dispersed l
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
ocales who buy and sell assets themselves, communicating with other dealers either electronically or lit
1 1 1 1 1 1 1 1 1 1 1 1 1 1
erally over-the-counter. 1
10. Such organizations frequently pursue social or political missions, so many different goals are conceiva
1 1 1 1 1 1 1 1 1 1 1 1 1
ble. One goal that is often cited is revenue minimization; i.e., provide whatever goods and services are o
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
ffered at the lowest possible cost to society. A better approach might be to observe that even a not-for-
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
profit business has equity. Thus, one answer is that the appropriate goal is to maximize the value of the
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
equity.
11. Presumably, the current stock value reflects the risk, timing, and magnitude of all future cash flows, bot
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
h short-term and long-term. If this is correct, then the statement is false.
1 1 1 1 1 1 1 1 1 1 1 1
12. An argument can be made either way. At the one extreme, we could argue that in a market economy,all
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
of these things are priced. There is thus an optimal level of, for example, ethical and/or illegal behavior,
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
and the framework of stock valuation explicitly includes these. At the other extreme, we could argue th
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
at these are non-
1 1 1
economic phenomena and are best handled through the political process. A classic (and highly relevant
1 1 1 1 1 1 1 1 1 1 1 1 1 1
) thought question that illustrates this debate goes something like this: ―A firm has estimated that the co
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
st of improving the safety of one of its products is $30 million. However, the firm believes that improvi
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
ng the safety of the product will only save $20 million in product liability claims. What should the firm
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
do?‖
13. The goal will be the same, but the best course of action toward that goal may be different because of diff
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
ering social, political, and economic institutions.
1 1 1 1 1
14. The goal of management should be to maximize the share price for the current shareholders. If manage
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
ment believes that it can improve the profitability of the firm so that the share price will exceed $35, the
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
n they should fight the offer from the outside company. If management believes that this bidder or other
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
unidentified bidders will actually pay more than $35 per share to acquire the company, then they shoul
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
d still fight the offer. However, if the current management cannot increase the value of the firm beyond
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
the bid price, and no other higher bids come in, then management is not acting in the interests of the sha
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
reholders by fighting the offer. Since current managers often lose their jobs when the corporation is acq
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
uired, poorly monitored managers have an incentive to fight corporate takeovers in situations such as th
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
is.
15. We would expect agency problems to be less severe in other countries, primarily due to the relativelys
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
mall percentage of individual ownership. Fewer individual owners should reduce the number of diverse
1 1 1 1 1 1 1 1 1 1 1 1 1
opinions concerning corporate goals. The high percentage of institutional ownership might lead to a hi
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
gher degree of agreement between owners and managers on decisions concerning risky projects. In add
1 1 1 1 1 1 1 1 1 1 1 1 1 1
ition, institutions may be better able to implement effective monitoring mechanisms on managers than
1 1 1 1 1 1 1 1 1 1 1 1 1 1
can individual owners, based on the institutions‘ deeper resources and experiences with their own mana
1 1 1 1 1 1 1 1 1 1 1 1 1 1
gement. The increase in institutional ownership of stock in the United States andthe growing activism o
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
f these large shareholder groups may lead to a reduction in agency problems for U.S. corporations and a
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
more efficient market for corporate control.
1 1 1 1 1 1
