Parrino et al. Fundamentals of Corporate Finance, 5th edition Solutions Manual
Solution Manual For
Fundamentals of Corporate Finance, 6th Edition Robert Parrino, Thomas W. Bates, Stuart L.
Gillan, David S. Kidwell February 2025
Chapter 1-21
Chapter 1: The Financial Manager and the Firm
Annotated Lecture Outline
Learning Objective 1.1: Identify the key financial decisions facing the financial manager of
any business.
The financial manager faces three basic decisions (1) which productive assets the firm should
buy (capital budgeting decisions), (2) how the firm should finance the productive assets
purchased (financing decisions), and (3) how the firm should manage its day-to-day financial
activities (working capital decisions). The financial manager should make these decisions in a
way that maximizes the current value of the firm’s stock.
THE ROLE OF THE FINANCIAL MANAGER
a. The financial manager is responsible for making decisions that are in the best
interests of the firm’s owners.
i. The decisions made by a financial manager or owner should be one and
the same.
ii. The financial manager should make decisions that maximize the value of
the owners’ stock.
iii. This helps maximize the owners’ wealth, which is the economic value of
the assets the owner possesses.
STAKEHOOLDERS
a. A stakeholder is someone other than an owner who has a claim on the cash flows of
the firm.
i. Stakeholders include managers, who want to be paid salaries and
performance bonuses.
ii. Other employees who want to be paid wages.
iii. Suppliers who want to be paid for goods and services.
iv. Creditors who want to be paid interest and principal.
v. Government which wants the firm to pay taxes.
IT’S ALL ABOUT CASH FLOWS
Copyright © 2022 John Wiley & Sons, Inc. SM 4-1
,Parrino et al. Fundamentals of Corporate Finance, 5th edition Solutions Manual
a. Productive assets are long-term assets.
i. Productive assets can be tangible and intangible assets.
b. Capital budgeting is the decision making process through which the firm purchases
productive assets.
i. Capital budgeting is one of the most important decision processes in a
firm.
c. Financing decisions determine the ways in which firms obtain and manage long-term
financing to acquire and support their productive assets.
d. The two basic sources of funds are debt and equity.
e. Residual cash flows is cash that remains after a firm meets its obligations.
i. A firm can pay a cash dividend, repurchase shares, or reinvest in the
business.
f. A firm is unprofitable if it fails to generate sufficient cash inflows to pay operating
expenses.
i. Firms that are unprofitable over time will be forced into bankruptcy.
THREE FUNDAMENTAL DECISIONS IN FINANCIAL MANAGEMENT
a. Capital budgeting decisions.
i. Identifying the productive assets the firm should buy.
b. Financing decisions.
i. Determining how the firm should finance or pay for assets.
c. Working capital management decisions.
i. Determining how day-to-day financial matters should be managed so that
the firm can pay its bills, and how surplus cash should be invested.
CAPITAL BUDGETING DECISIONS
a. A capital budget is a list of the productive (capital) assets that management wants to
purchase over a budget cycle.
g. Process addresses which productive assets the firm should purchase and how much
money the firm can afford to spend.
i. Capital budgeting has a large impact on a firm’s success or failure.
FINANCING DECISIONS
a. Financing decisions determine how firms raise cash to pay for their investments.
b. A major advantage of debt financing is that interest payments are tax deductible for many
corporations.
i. Debt financing increases a firm’s risk because it creates a contractual
obligation.
d. Equity has no maturity, and there are no guaranteed payments to equity investors.
e. The mix of debt and equity on the balance sheet is known as a firm’s capital structure.
Copyright © 2022 John Wiley & Sons, Inc. SM 4-2
,Parrino et al. Fundamentals of Corporate Finance, 5th edition Solutions Manual
f. Capital markets are financial markets where equity and debt instruments with maturities
greater than one year are traded.
WORKING CAPITAL MANAGEMENT DECISIONS
a. Management must decide how to manage a firm’s current assets, such as cash, inventory,
and accounts receivable.
b. Management must decide how to manage the firm’s current liabilities, such as trade
credit and accounts payable.
c. The dollar difference between a firm’s current assets and its current liabilities is called its
net working capital.
d. The mismanagement of working capital can cause a firm to default on its debt and go into
bankruptcy.
e. A firm’s profitability can also be affected by its inventory level.
i. A financial calculator is an ordinary calculator that has preprogrammed
future value and present value algorithms.
ii. A calculator can help eliminate computation errors and save time.
Learning Objective 1.2: Identify common forms of business organization in the United
States and their respective strengths and weaknesses.
Businesses in the United States are commonly organized as a sole proprietorship, a general or
limited partnership, a corporation, or a limited liability partnership or company. Most large
firms elect to organize as C-corporations because of the ease of raising money; the major
disadvantage is double taxation. Smaller companies tend to organize as sole proprietorships or
partnerships. The advantages of these firms of organization include ease of formation and
taxation at the personal income tax rate, The major disadvantage is the owners’ unlimited
personal liability. Limited liability partnerships and companies and S-corporations provide
owners of small businesses, who make the business decisions, with limited personal liability.
SOLE PROPRIETORSHIPS
a. A sole proprietorship is a business that is owned by a single person.
i. Life is limited to the period that the owner (proprietor) is associated with
the business.
ii. Simples and least expensive form of business to set up and is the least
regulated.
iii. One advantage of this type of structure is that the proprietor does not have
to share decision making with anyone.
iv. Disadvantages include the amount of equity capital that can be raised to
finance the business, more costly to transfer ownership, and the proprietor
must provide all the equity capital and manage the business.
Copyright © 2022 John Wiley & Sons, Inc. SM 4-3
, Parrino et al. Fundamentals of Corporate Finance, 5th edition Solutions Manual
PARTNERSHIPS
a. A partnership consists of two or more owners who have joined together legally to
manage a business.
b. To form a partnership, the owners (partners) enter into an agreement that details how
much capital each partner will invest in the partnership, what their management roles
will be, how key management decisions will be made, and how profits will be
divided.
c. Partnerships are more costly to form.
d. A key disadvantage of a general partnership is that all partners have unlimited
liability.
i. The problem of unlimited liability can be avoided in a limited partnership
because limited partners can generally only lose the amount of money that
they have invested in the business.
CORPORATIONS
a. A corporation is a legal entity authorized under a state charter.
i. Can sue and be sued.
ii. Can enter into contracts.
iii. Borrow money.
iv. Own assets.
b. Starting a corporation is more costly than starting a sole proprietorship.
i. Requires writing articles of incorporation and by-laws that conform to the
laws of the state of incorporation.
c. Corporate form of organization has several advantages.
i. Shares can be sold to raise capital from investors who are not involved in
the business.
ii. Stockholders have limited liability because corporations are legal person
that take actions in their own names,
iii. Stockholders have limited liability for debts and other obligations.
d. An s-corporation is a form of corporation that can be used by private businesses.
i. Can only have one class of stock and cannot have more than one hundred
stockholders.
ii. Stockholders cannot be corporations or nonresident alien investors.
LIMITED LIABILITY PARTNERSHIPS AND COMPANIES
a. Limited liability partnerships (LLP, combines some of the limited liability
characteristics of a corporation with the tax advantage of a partnership.
i. Partners are not personally liable for any other partner’s malpractice or
professional misconduct.
Copyright © 2022 John Wiley & Sons, Inc. SM 4-4
Solution Manual For
Fundamentals of Corporate Finance, 6th Edition Robert Parrino, Thomas W. Bates, Stuart L.
Gillan, David S. Kidwell February 2025
Chapter 1-21
Chapter 1: The Financial Manager and the Firm
Annotated Lecture Outline
Learning Objective 1.1: Identify the key financial decisions facing the financial manager of
any business.
The financial manager faces three basic decisions (1) which productive assets the firm should
buy (capital budgeting decisions), (2) how the firm should finance the productive assets
purchased (financing decisions), and (3) how the firm should manage its day-to-day financial
activities (working capital decisions). The financial manager should make these decisions in a
way that maximizes the current value of the firm’s stock.
THE ROLE OF THE FINANCIAL MANAGER
a. The financial manager is responsible for making decisions that are in the best
interests of the firm’s owners.
i. The decisions made by a financial manager or owner should be one and
the same.
ii. The financial manager should make decisions that maximize the value of
the owners’ stock.
iii. This helps maximize the owners’ wealth, which is the economic value of
the assets the owner possesses.
STAKEHOOLDERS
a. A stakeholder is someone other than an owner who has a claim on the cash flows of
the firm.
i. Stakeholders include managers, who want to be paid salaries and
performance bonuses.
ii. Other employees who want to be paid wages.
iii. Suppliers who want to be paid for goods and services.
iv. Creditors who want to be paid interest and principal.
v. Government which wants the firm to pay taxes.
IT’S ALL ABOUT CASH FLOWS
Copyright © 2022 John Wiley & Sons, Inc. SM 4-1
,Parrino et al. Fundamentals of Corporate Finance, 5th edition Solutions Manual
a. Productive assets are long-term assets.
i. Productive assets can be tangible and intangible assets.
b. Capital budgeting is the decision making process through which the firm purchases
productive assets.
i. Capital budgeting is one of the most important decision processes in a
firm.
c. Financing decisions determine the ways in which firms obtain and manage long-term
financing to acquire and support their productive assets.
d. The two basic sources of funds are debt and equity.
e. Residual cash flows is cash that remains after a firm meets its obligations.
i. A firm can pay a cash dividend, repurchase shares, or reinvest in the
business.
f. A firm is unprofitable if it fails to generate sufficient cash inflows to pay operating
expenses.
i. Firms that are unprofitable over time will be forced into bankruptcy.
THREE FUNDAMENTAL DECISIONS IN FINANCIAL MANAGEMENT
a. Capital budgeting decisions.
i. Identifying the productive assets the firm should buy.
b. Financing decisions.
i. Determining how the firm should finance or pay for assets.
c. Working capital management decisions.
i. Determining how day-to-day financial matters should be managed so that
the firm can pay its bills, and how surplus cash should be invested.
CAPITAL BUDGETING DECISIONS
a. A capital budget is a list of the productive (capital) assets that management wants to
purchase over a budget cycle.
g. Process addresses which productive assets the firm should purchase and how much
money the firm can afford to spend.
i. Capital budgeting has a large impact on a firm’s success or failure.
FINANCING DECISIONS
a. Financing decisions determine how firms raise cash to pay for their investments.
b. A major advantage of debt financing is that interest payments are tax deductible for many
corporations.
i. Debt financing increases a firm’s risk because it creates a contractual
obligation.
d. Equity has no maturity, and there are no guaranteed payments to equity investors.
e. The mix of debt and equity on the balance sheet is known as a firm’s capital structure.
Copyright © 2022 John Wiley & Sons, Inc. SM 4-2
,Parrino et al. Fundamentals of Corporate Finance, 5th edition Solutions Manual
f. Capital markets are financial markets where equity and debt instruments with maturities
greater than one year are traded.
WORKING CAPITAL MANAGEMENT DECISIONS
a. Management must decide how to manage a firm’s current assets, such as cash, inventory,
and accounts receivable.
b. Management must decide how to manage the firm’s current liabilities, such as trade
credit and accounts payable.
c. The dollar difference between a firm’s current assets and its current liabilities is called its
net working capital.
d. The mismanagement of working capital can cause a firm to default on its debt and go into
bankruptcy.
e. A firm’s profitability can also be affected by its inventory level.
i. A financial calculator is an ordinary calculator that has preprogrammed
future value and present value algorithms.
ii. A calculator can help eliminate computation errors and save time.
Learning Objective 1.2: Identify common forms of business organization in the United
States and their respective strengths and weaknesses.
Businesses in the United States are commonly organized as a sole proprietorship, a general or
limited partnership, a corporation, or a limited liability partnership or company. Most large
firms elect to organize as C-corporations because of the ease of raising money; the major
disadvantage is double taxation. Smaller companies tend to organize as sole proprietorships or
partnerships. The advantages of these firms of organization include ease of formation and
taxation at the personal income tax rate, The major disadvantage is the owners’ unlimited
personal liability. Limited liability partnerships and companies and S-corporations provide
owners of small businesses, who make the business decisions, with limited personal liability.
SOLE PROPRIETORSHIPS
a. A sole proprietorship is a business that is owned by a single person.
i. Life is limited to the period that the owner (proprietor) is associated with
the business.
ii. Simples and least expensive form of business to set up and is the least
regulated.
iii. One advantage of this type of structure is that the proprietor does not have
to share decision making with anyone.
iv. Disadvantages include the amount of equity capital that can be raised to
finance the business, more costly to transfer ownership, and the proprietor
must provide all the equity capital and manage the business.
Copyright © 2022 John Wiley & Sons, Inc. SM 4-3
, Parrino et al. Fundamentals of Corporate Finance, 5th edition Solutions Manual
PARTNERSHIPS
a. A partnership consists of two or more owners who have joined together legally to
manage a business.
b. To form a partnership, the owners (partners) enter into an agreement that details how
much capital each partner will invest in the partnership, what their management roles
will be, how key management decisions will be made, and how profits will be
divided.
c. Partnerships are more costly to form.
d. A key disadvantage of a general partnership is that all partners have unlimited
liability.
i. The problem of unlimited liability can be avoided in a limited partnership
because limited partners can generally only lose the amount of money that
they have invested in the business.
CORPORATIONS
a. A corporation is a legal entity authorized under a state charter.
i. Can sue and be sued.
ii. Can enter into contracts.
iii. Borrow money.
iv. Own assets.
b. Starting a corporation is more costly than starting a sole proprietorship.
i. Requires writing articles of incorporation and by-laws that conform to the
laws of the state of incorporation.
c. Corporate form of organization has several advantages.
i. Shares can be sold to raise capital from investors who are not involved in
the business.
ii. Stockholders have limited liability because corporations are legal person
that take actions in their own names,
iii. Stockholders have limited liability for debts and other obligations.
d. An s-corporation is a form of corporation that can be used by private businesses.
i. Can only have one class of stock and cannot have more than one hundred
stockholders.
ii. Stockholders cannot be corporations or nonresident alien investors.
LIMITED LIABILITY PARTNERSHIPS AND COMPANIES
a. Limited liability partnerships (LLP, combines some of the limited liability
characteristics of a corporation with the tax advantage of a partnership.
i. Partners are not personally liable for any other partner’s malpractice or
professional misconduct.
Copyright © 2022 John Wiley & Sons, Inc. SM 4-4
