Solutions Manual `
Fundamentals`of`Corporate`Finance`13th`edition`
Ross,`Westerfield,`and`Jordan
Prepared`by
`Brad`Jorda
n
University`of`Florida
Joe`Smolira`Belmo
nt`University
,CHAPTER 1 `
INTRODUCTION TO CORPORATE FINAN ` ` `
CE
Answers`to`Concepts`Review`and`Critical`Thinking`Questions
1. Capital`budgeting`(deciding`whether`to`expand`a`manufacturing`plant),`capital`structure`(deciding`wh
ether`to`issue`new`equity`and`use`the`proceeds`to`retire`outstanding`debt),`and`working`capital`manag
ement`(modifying`the`firm‘s`credit`collection`policy`with`its`customers).
2. Disadvantages:`unlimited`liability,`limited`life,`difficulty`in`transferring`ownership,`difficulty`in`raisi
ng`capital`funds.`Some`advantages:`simpler,`less`regulation,`the`owners`are`also`the`managers,`someti
mes`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`r
aise`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`w
ith`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`a
nd`the`private`equity`market,`the`costs`associated`with`raising`funds`in`these`markets`are`usually`high
er`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` repor
t`directly`to`the`chief`financial`officer.`The`controller‘s`office`handles`cost`and`financial`accounting,`t
ax`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`corpo
rate`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`tra
ded`or`not).
7. In`the`corporate`form`of`ownership,`the`shareholders`are`the`owners`of`the`firm.`The`shareholders`ele
ct`the`directors`of`the`corporation,`who`in`turn`appoint`the`firm‘s`management.`This`separation`of`ow
nership`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.
,2` SOLUTIONS`MANUAL
9. In`auction`markets`like`the`NYSE,`brokers`and`agents`meet`at`a`physical`location`(the`exchange)`to`m
atch`buyers`and`sellers`of`assets.`Dealer`markets`like`NASDAQ`consist`of`dealers`operating`at`disper
sed`locales`who`buy`and`sell`assets`themselves,`communicating`with`other`dealers`either`electronicall
y`or`literally`over-the-counter.
10. Such`organizations`frequently`pursue`social`or`political`missions,`so`many`different`goals`are`conceiv
able.`One`goal`that`is`often`cited`is`revenue`minimization;`that`is,`provide`whatever`goods` and`servic
es`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`t
he`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`beh
avior,`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`cl
assic`(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.`Howeve
r,`the`firm`believes`that`improving`the`safety`of`the`product`will`only`save`$20`million`in`product`liab
ility`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`mana
gement`believes`that`it`can`improve`the`profitability`of`the`firm`so`that`the`share`price`will`exceed`$3
5,`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`t
hey`should`still`fight`the`offer.`However,`if`the`current`management`cannot`increase`the`value`of`the`f
irm`beyond`the`bid`price,`and`no`other`higher`bids`come`in,`then`management`is`not`acting`in`the`inte
rests`of`the`shareholders`by`fighting`the`offer.`Since`current`managers`often`lose`their`jobs`when`the`c
orporation`is`acquired,`poorly`monitored`managers`have`an`incentive`to`fight`corporate`takeovers`in`s
ituations`such`as`this.
15. We`would`expect`agency`problems`to`be`less`severe`in`countries`with`a`relatively`small`percentage` o
f`individual`ownership.`Fewer`individual`owners`should`reduce`the`number`of`diverse`opinions`conce
rning`corporate`goals.`The`high`percentage`of`institutional`ownership`might`lead`to`a`higher`degree`o
f`agreement`between`owners`and`managers`on`decisions`concerning`risky`projects.`In`addition,`instit
utions`may`be`better`able`to`implement`effective`monitoring`mechanisms`on`managers`than`can`indiv
idual`owners,`based`on`the`institutions‘`deeper`resources`and`experiences`with`their`own`managemen
t.`The`increase`in`institutional`ownership`of`stock`in`the`United`States`and`the`growing`activism`of`th
ese`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`t
he`price`that`clears`the`market.`The`same`is`true`for`athletes`and`performers.`Having`said`that,`one`as
pect`of`executive`compensation`deserves`comment.`A`primary`reason`executive`compensation`has`gr
own`so`dramatically`is`that`companies`have`increasingly`moved`to`stock-
based`compensation.` Such`movement`is`obviously`consistent`with`the`attempt`to`better`align`stockho
lder`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`mana
gerial`performance.`Perhaps`in`the`future,`executive`compensation`will`be`designed`to`reward`only`di
fferential`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`me
eting`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`f
ind`a`reasonable`compromise`between`these`opposing`needs.
2. The`recognition`and`matching`principles`in`financial`accounting`call`for`revenues,`and`the`costs`assoc
iated`with`producing`those`revenues,`to`be`―booked‖`when`the`revenue`process`is`essentially`comple
te,`not`necessarily`when`the`cash`is`collected`or`bills`are`paid.`Note`that`this`way`is`not`necessarily`co
rrect;`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`accordanc
e`with`the`matching`principle`in`financial`accounting.`Interest`expense`is`a`cash`outlay,`but`it‘s`a`fina
ncing`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`13th`edition`
Ross,`Westerfield,`and`Jordan
Prepared`by
`Brad`Jorda
n
University`of`Florida
Joe`Smolira`Belmo
nt`University
,CHAPTER 1 `
INTRODUCTION TO CORPORATE FINAN ` ` `
CE
Answers`to`Concepts`Review`and`Critical`Thinking`Questions
1. Capital`budgeting`(deciding`whether`to`expand`a`manufacturing`plant),`capital`structure`(deciding`wh
ether`to`issue`new`equity`and`use`the`proceeds`to`retire`outstanding`debt),`and`working`capital`manag
ement`(modifying`the`firm‘s`credit`collection`policy`with`its`customers).
2. Disadvantages:`unlimited`liability,`limited`life,`difficulty`in`transferring`ownership,`difficulty`in`raisi
ng`capital`funds.`Some`advantages:`simpler,`less`regulation,`the`owners`are`also`the`managers,`someti
mes`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`r
aise`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`w
ith`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`a
nd`the`private`equity`market,`the`costs`associated`with`raising`funds`in`these`markets`are`usually`high
er`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` repor
t`directly`to`the`chief`financial`officer.`The`controller‘s`office`handles`cost`and`financial`accounting,`t
ax`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`corpo
rate`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`tra
ded`or`not).
7. In`the`corporate`form`of`ownership,`the`shareholders`are`the`owners`of`the`firm.`The`shareholders`ele
ct`the`directors`of`the`corporation,`who`in`turn`appoint`the`firm‘s`management.`This`separation`of`ow
nership`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.
,2` SOLUTIONS`MANUAL
9. In`auction`markets`like`the`NYSE,`brokers`and`agents`meet`at`a`physical`location`(the`exchange)`to`m
atch`buyers`and`sellers`of`assets.`Dealer`markets`like`NASDAQ`consist`of`dealers`operating`at`disper
sed`locales`who`buy`and`sell`assets`themselves,`communicating`with`other`dealers`either`electronicall
y`or`literally`over-the-counter.
10. Such`organizations`frequently`pursue`social`or`political`missions,`so`many`different`goals`are`conceiv
able.`One`goal`that`is`often`cited`is`revenue`minimization;`that`is,`provide`whatever`goods` and`servic
es`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`t
he`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`beh
avior,`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`cl
assic`(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.`Howeve
r,`the`firm`believes`that`improving`the`safety`of`the`product`will`only`save`$20`million`in`product`liab
ility`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`mana
gement`believes`that`it`can`improve`the`profitability`of`the`firm`so`that`the`share`price`will`exceed`$3
5,`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`t
hey`should`still`fight`the`offer.`However,`if`the`current`management`cannot`increase`the`value`of`the`f
irm`beyond`the`bid`price,`and`no`other`higher`bids`come`in,`then`management`is`not`acting`in`the`inte
rests`of`the`shareholders`by`fighting`the`offer.`Since`current`managers`often`lose`their`jobs`when`the`c
orporation`is`acquired,`poorly`monitored`managers`have`an`incentive`to`fight`corporate`takeovers`in`s
ituations`such`as`this.
15. We`would`expect`agency`problems`to`be`less`severe`in`countries`with`a`relatively`small`percentage` o
f`individual`ownership.`Fewer`individual`owners`should`reduce`the`number`of`diverse`opinions`conce
rning`corporate`goals.`The`high`percentage`of`institutional`ownership`might`lead`to`a`higher`degree`o
f`agreement`between`owners`and`managers`on`decisions`concerning`risky`projects.`In`addition,`instit
utions`may`be`better`able`to`implement`effective`monitoring`mechanisms`on`managers`than`can`indiv
idual`owners,`based`on`the`institutions‘`deeper`resources`and`experiences`with`their`own`managemen
t.`The`increase`in`institutional`ownership`of`stock`in`the`United`States`and`the`growing`activism`of`th
ese`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`t
he`price`that`clears`the`market.`The`same`is`true`for`athletes`and`performers.`Having`said`that,`one`as
pect`of`executive`compensation`deserves`comment.`A`primary`reason`executive`compensation`has`gr
own`so`dramatically`is`that`companies`have`increasingly`moved`to`stock-
based`compensation.` Such`movement`is`obviously`consistent`with`the`attempt`to`better`align`stockho
lder`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`mana
gerial`performance.`Perhaps`in`the`future,`executive`compensation`will`be`designed`to`reward`only`di
fferential`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`me
eting`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`f
ind`a`reasonable`compromise`between`these`opposing`needs.
2. The`recognition`and`matching`principles`in`financial`accounting`call`for`revenues,`and`the`costs`assoc
iated`with`producing`those`revenues,`to`be`―booked‖`when`the`revenue`process`is`essentially`comple
te,`not`necessarily`when`the`cash`is`collected`or`bills`are`paid.`Note`that`this`way`is`not`necessarily`co
rrect;`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`accordanc
e`with`the`matching`principle`in`financial`accounting.`Interest`expense`is`a`cash`outlay,`but`it‘s`a`fina
ncing`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.
