1-6 What issue does agency theory examine? Why is it important in a publi
Solution Manual for rather than in a private corporation?
Foundations of Financial Management, 18th Edition by Stanley Block,
Agency theory examines the relationship between the owners of the fir
Geoffrey Hirt, Bartley Danielsen
managers of the firm. In privately owned firms, management and the o
the same people. Management operates the firm to satisfy its own goals
Chapter 1-21 requirements and the like. As a company moves from private to public
management now represents all owners. This places management in the
Chapter 1 of making decisions in the best interest of all shareholders.
The Goals and Functions of Financial Management 1-7 What are institutional investors important in today’s business world?
Because institutional investors such as pension funds and mutual funds
Discussion Questions percentage of major U.S. companies, they are having more to say abou
owned companies are managed. As a group, they have the ability to vo
1-1 What effect did the recession of 2007-2009 have on government regulation? shares for the election of a board of directors, which is supposed to run
efficient, competitive manner. The threat of being able to replace poor
It was greatly increased. of directors makes institutional investors quite influential. Since these i
pension funds and mutual funds, represent individual workers and inve
1-2 What advantages does a sole proprietorship offer? What is a major drawback of this type responsibility to see that the firm is managed in an efficient and ethical
of organization?
1-8 Why is profit maximization, by itself, an inappropriate goal? What is m
A sole proprietorship offers the advantage of simplicity of decision making and low of maximization of shareholder wealth?
organizational and operating costs. A major drawback is that there is unlimited liability to
the owner. The problem with a profit maximization goal is that it fails to take acco
timing of the benefits is not considered, and profit measurement is a ve
1-3 What form of partnership allows some of the investors to limit their liability? Explain The goal of shareholders’ wealth maximization implies that the firm wi
briefly. achieve the highest possible total valuation in the marketplace. It is the
objective of the firm and should influence every decision.
A limited partnership allows some of the partners to limit their liability. Under this
arrangement, one or more partners are designated general partners and have unlimited 1-9 When does insider trading occur? What government agency is responsi
liability for the debts of the firm; other partners are designated limited partners and are against the unethical practice of insider trading?
liable only for their initial contribution. The limited partners are normally prohibited from
being active in the management of the firm. Insider trading occurs when anyone with non-public information buys o
take advantage of that private information. The Securities and Exchang
1-4 In a corporation, what group has the ultimate responsibility for protecting and managing responsible for protecting markets against insider trading. In the past, p
the stockholders’ interests? jail for trading on non-public information. This has included company
investment bankers, printers who have information before it is publishe
The board of directors. drivers who deliver business magazines and read positive or negative a
company before the magazine is on the newsstands and then place trade
1-5 What document is necessary to form a corporation? place trades based on that information. The SEC has prosecuted anyone
inside information.
The articles of incorporation.
1-10 In terms of the life of the securities offered, what is the difference betw
markets?
, Money markets refer to those markets dealing with short-term securities that have a life of 2-2. What is the difference between book value per share of common sto
one year or less. Capital markets refer to securities with a life of more than one year. value per share? Why does this disparity occur?
1-11 What is the difference between a primary and a secondary market?
Book value per share is arrived at by taking the cost of the assets and
A primary market refers to the use of the financial markets to raise new funds for the liabilities and preferred stock and dividing by the number of commo
corporation. After the securities are sold to the public (institutions and individuals), they outstanding. It is based on the historical cost of the assets. Market v
trade in the secondary market between investors. It is in the secondary market that prices based on the current assessed value of the firm in the marketplace a
are continually changing as investors buy and sell securities based on the expectations of relationship to original cost. Besides the disparity between book and
corporate prospects. caused by the historical cost approach, other contributing factors ar
prospects for the firm, the quality of management, and the industry
1-12 Assume you are looking at many companies with equal risk. Which ones will have the highest extent these are quite negative or positive; market value may differ
stock prices? value.
Given companies with equal risk, those companies with expectations of high return will
have higher common stock prices relative to those companies with expectations of poor 2-3. Explain how depreciation generates actual cash flows for the compa
returns.
1-13 How is the time value of money concept related to the valuation of stocks? The only way depreciation generates cash flows for the company is b
shield against reported income. This non-cash deduction may provid
The value of an investment that is expected to earn money in the future can be calculated the tax rate times the depreciation charged. This much in taxes will b
using time-value of money principles. Corporations are expected to pay dividends to their cash payments occur.
shareholders. The current value of these future dividends is the present value. The present
value of a stock’s future dividends should be the same as the stock’s current price.
2-4. What is the difference between accumulated depreciation and depre
How are they related?
Chapter 2 Accumulated depreciation is the sum of all past and present depreci
Review of Accounting depreciation expense is the current year’s charge. They are related i
prior depreciation expense should be equal to accumulated deprecia
(subject to some differential related to asset write-offs).
Discussion Questions
2-1. Discuss some financial variables that affect the price-earnings ratio. 2-5. How is the income statement related to the balance sheet?
The price-earnings ratio will be influenced by the earnings and sales growth of the firm, The earnings (less dividends) reported in the income statement is tra
the risk or volatility in performance, the debt-equity structure of the firm, the dividend ownership section of the balance sheet as retained earnings. Thus, w
payment policy, the quality of management, and a number of other factors. The ratio the income statement becomes part of the ownership interest in the
tends to be future-oriented, and the more positive the outlook, the higher it will be.
2-6. Comment on why inflation may restrict the usefulness of the balance sheet as n
, The balance sheet is based on historical costs. When prices are rising rapidly, historical Minus: Dividends (required to maintain the payout on common stoc
cost data may lose much of their meaning—particularly for plant and equipment and preferred stock obligation).
inventory.
The analyst or banker normally looks at free cash flow to determine
2-7. Explain why the statement of cash flows provides useful information that goes beyond sufficient excess funds to pay back the loan associated with the leve
income statement and balance sheet data.
2-10. Why is interest expense said to cost the firm substantially less than t
while dividends cost it 100 percent of the outlay?
The income statement and balance sheet are based on the accrual method of
accounting, which attempts to match revenues and expenses in the period in which
they occur. However, accrual accounting does not attempt to properly assess the cash Interest expense is a tax-deductible item to the corporation, while d
flow position of the firm. The statement of cash flows fulfills this need. are not. The net cost to the corporation of interest expense is the am
multiplied by the difference of one minus the applicable tax rate.
2-8. What are the three primary sections of the statement of cash flows? In what section
would the payment of a cash dividend be shown? For example, $100 of interest expense costs the company $65 after t
corporate tax rate is 35 percent—for example, $100 × (1 – 0.35) = $6
The sections of the statement of cash flows are:
Cash flows from operating activities
Problems
Cash flows from investing activities
1. Income Statement (LO1) Frantic Fast Foods had earnings after taxes of $410,0
Cash flows from financing activities with 301,000 shares outstanding. On January 1, 20X2, the firm issued 30,000 n
of the proceeds from these new shares and other operating improvements, ea
increased by 25 percent.
The payment of cash dividends falls into the financing activities category.
a. Compute earnings per share for the year 20X1.
b. Compute earnings per share for the year 20X2.
2-9. What is free cash flow? Why is it important to leveraged buyouts?
2-1. Solution:
Frantic Fast Foods
Free cash flow is equal to cash flow from operating activities:
a. Year 20X1
Minus: Capital expenditures required to maintain the productive capacity of the
firm.
, b. Year 20X2
Earnings after taxes $800,000 1.30 $1,04
= $410,,000 = $1.36
Shares outstanding 200,000 50,000 250
b. Year 20X2 $1,040,000
Earning per share $4.16 250,000
Earnings after taxes = $410,000 × 1.25 = $512,500 Shares
outstanding = 301,000 + 30,000 = 331,000
3. a. Gross profit (LO1) Swank Clothiers had sales of $375,000 and cost of
$246,000. What is the gross profit margin (ratio of gross profit to sales)?
b. If the average firm in the clothing industry had a gross profit of 30 perce
Earnings per share = $512,,000 = $1.55
doing?
2. Income statement (LO1) Sosa Diet Supplements had earnings after taxes of $800,000 in the year
2-3. Solution:
20X1 with 200,000 shares of stock outstanding. On January 1, 20X2, the firm issued 50,000 new
shares. Because of the proceeds from these new shares and other operating improvements,
Swank Clothiers
earnings after taxes increased by 30 percent.
a. Compute earnings per share for the year 20X1.
a. Sales ............................................................ $375,0
Cost of goods sold ........................ 246,0
b. Compute earnings per share for the year 20X2.
Gross Profit ........................ $129,0
2-2. Solution:
Sosa Diet Supplements
a. Year 20X1
b. With a gross profit of 34 percent, the firm is outpe
Earnings after taxes industry average of 30 percent.
Earnings per share =
Shares outstanding
4. Operating profit (LO1) A-Rod Fishing Supplies had sales of $2,500,000 and cos
$1,710,000. Selling and administrative expenses represented 10 percent of sal
was 6 percent of the total assets of $4,680,000. What was the firm’s operating
= = $4.00
Solution Manual for rather than in a private corporation?
Foundations of Financial Management, 18th Edition by Stanley Block,
Agency theory examines the relationship between the owners of the fir
Geoffrey Hirt, Bartley Danielsen
managers of the firm. In privately owned firms, management and the o
the same people. Management operates the firm to satisfy its own goals
Chapter 1-21 requirements and the like. As a company moves from private to public
management now represents all owners. This places management in the
Chapter 1 of making decisions in the best interest of all shareholders.
The Goals and Functions of Financial Management 1-7 What are institutional investors important in today’s business world?
Because institutional investors such as pension funds and mutual funds
Discussion Questions percentage of major U.S. companies, they are having more to say abou
owned companies are managed. As a group, they have the ability to vo
1-1 What effect did the recession of 2007-2009 have on government regulation? shares for the election of a board of directors, which is supposed to run
efficient, competitive manner. The threat of being able to replace poor
It was greatly increased. of directors makes institutional investors quite influential. Since these i
pension funds and mutual funds, represent individual workers and inve
1-2 What advantages does a sole proprietorship offer? What is a major drawback of this type responsibility to see that the firm is managed in an efficient and ethical
of organization?
1-8 Why is profit maximization, by itself, an inappropriate goal? What is m
A sole proprietorship offers the advantage of simplicity of decision making and low of maximization of shareholder wealth?
organizational and operating costs. A major drawback is that there is unlimited liability to
the owner. The problem with a profit maximization goal is that it fails to take acco
timing of the benefits is not considered, and profit measurement is a ve
1-3 What form of partnership allows some of the investors to limit their liability? Explain The goal of shareholders’ wealth maximization implies that the firm wi
briefly. achieve the highest possible total valuation in the marketplace. It is the
objective of the firm and should influence every decision.
A limited partnership allows some of the partners to limit their liability. Under this
arrangement, one or more partners are designated general partners and have unlimited 1-9 When does insider trading occur? What government agency is responsi
liability for the debts of the firm; other partners are designated limited partners and are against the unethical practice of insider trading?
liable only for their initial contribution. The limited partners are normally prohibited from
being active in the management of the firm. Insider trading occurs when anyone with non-public information buys o
take advantage of that private information. The Securities and Exchang
1-4 In a corporation, what group has the ultimate responsibility for protecting and managing responsible for protecting markets against insider trading. In the past, p
the stockholders’ interests? jail for trading on non-public information. This has included company
investment bankers, printers who have information before it is publishe
The board of directors. drivers who deliver business magazines and read positive or negative a
company before the magazine is on the newsstands and then place trade
1-5 What document is necessary to form a corporation? place trades based on that information. The SEC has prosecuted anyone
inside information.
The articles of incorporation.
1-10 In terms of the life of the securities offered, what is the difference betw
markets?
, Money markets refer to those markets dealing with short-term securities that have a life of 2-2. What is the difference between book value per share of common sto
one year or less. Capital markets refer to securities with a life of more than one year. value per share? Why does this disparity occur?
1-11 What is the difference between a primary and a secondary market?
Book value per share is arrived at by taking the cost of the assets and
A primary market refers to the use of the financial markets to raise new funds for the liabilities and preferred stock and dividing by the number of commo
corporation. After the securities are sold to the public (institutions and individuals), they outstanding. It is based on the historical cost of the assets. Market v
trade in the secondary market between investors. It is in the secondary market that prices based on the current assessed value of the firm in the marketplace a
are continually changing as investors buy and sell securities based on the expectations of relationship to original cost. Besides the disparity between book and
corporate prospects. caused by the historical cost approach, other contributing factors ar
prospects for the firm, the quality of management, and the industry
1-12 Assume you are looking at many companies with equal risk. Which ones will have the highest extent these are quite negative or positive; market value may differ
stock prices? value.
Given companies with equal risk, those companies with expectations of high return will
have higher common stock prices relative to those companies with expectations of poor 2-3. Explain how depreciation generates actual cash flows for the compa
returns.
1-13 How is the time value of money concept related to the valuation of stocks? The only way depreciation generates cash flows for the company is b
shield against reported income. This non-cash deduction may provid
The value of an investment that is expected to earn money in the future can be calculated the tax rate times the depreciation charged. This much in taxes will b
using time-value of money principles. Corporations are expected to pay dividends to their cash payments occur.
shareholders. The current value of these future dividends is the present value. The present
value of a stock’s future dividends should be the same as the stock’s current price.
2-4. What is the difference between accumulated depreciation and depre
How are they related?
Chapter 2 Accumulated depreciation is the sum of all past and present depreci
Review of Accounting depreciation expense is the current year’s charge. They are related i
prior depreciation expense should be equal to accumulated deprecia
(subject to some differential related to asset write-offs).
Discussion Questions
2-1. Discuss some financial variables that affect the price-earnings ratio. 2-5. How is the income statement related to the balance sheet?
The price-earnings ratio will be influenced by the earnings and sales growth of the firm, The earnings (less dividends) reported in the income statement is tra
the risk or volatility in performance, the debt-equity structure of the firm, the dividend ownership section of the balance sheet as retained earnings. Thus, w
payment policy, the quality of management, and a number of other factors. The ratio the income statement becomes part of the ownership interest in the
tends to be future-oriented, and the more positive the outlook, the higher it will be.
2-6. Comment on why inflation may restrict the usefulness of the balance sheet as n
, The balance sheet is based on historical costs. When prices are rising rapidly, historical Minus: Dividends (required to maintain the payout on common stoc
cost data may lose much of their meaning—particularly for plant and equipment and preferred stock obligation).
inventory.
The analyst or banker normally looks at free cash flow to determine
2-7. Explain why the statement of cash flows provides useful information that goes beyond sufficient excess funds to pay back the loan associated with the leve
income statement and balance sheet data.
2-10. Why is interest expense said to cost the firm substantially less than t
while dividends cost it 100 percent of the outlay?
The income statement and balance sheet are based on the accrual method of
accounting, which attempts to match revenues and expenses in the period in which
they occur. However, accrual accounting does not attempt to properly assess the cash Interest expense is a tax-deductible item to the corporation, while d
flow position of the firm. The statement of cash flows fulfills this need. are not. The net cost to the corporation of interest expense is the am
multiplied by the difference of one minus the applicable tax rate.
2-8. What are the three primary sections of the statement of cash flows? In what section
would the payment of a cash dividend be shown? For example, $100 of interest expense costs the company $65 after t
corporate tax rate is 35 percent—for example, $100 × (1 – 0.35) = $6
The sections of the statement of cash flows are:
Cash flows from operating activities
Problems
Cash flows from investing activities
1. Income Statement (LO1) Frantic Fast Foods had earnings after taxes of $410,0
Cash flows from financing activities with 301,000 shares outstanding. On January 1, 20X2, the firm issued 30,000 n
of the proceeds from these new shares and other operating improvements, ea
increased by 25 percent.
The payment of cash dividends falls into the financing activities category.
a. Compute earnings per share for the year 20X1.
b. Compute earnings per share for the year 20X2.
2-9. What is free cash flow? Why is it important to leveraged buyouts?
2-1. Solution:
Frantic Fast Foods
Free cash flow is equal to cash flow from operating activities:
a. Year 20X1
Minus: Capital expenditures required to maintain the productive capacity of the
firm.
, b. Year 20X2
Earnings after taxes $800,000 1.30 $1,04
= $410,,000 = $1.36
Shares outstanding 200,000 50,000 250
b. Year 20X2 $1,040,000
Earning per share $4.16 250,000
Earnings after taxes = $410,000 × 1.25 = $512,500 Shares
outstanding = 301,000 + 30,000 = 331,000
3. a. Gross profit (LO1) Swank Clothiers had sales of $375,000 and cost of
$246,000. What is the gross profit margin (ratio of gross profit to sales)?
b. If the average firm in the clothing industry had a gross profit of 30 perce
Earnings per share = $512,,000 = $1.55
doing?
2. Income statement (LO1) Sosa Diet Supplements had earnings after taxes of $800,000 in the year
2-3. Solution:
20X1 with 200,000 shares of stock outstanding. On January 1, 20X2, the firm issued 50,000 new
shares. Because of the proceeds from these new shares and other operating improvements,
Swank Clothiers
earnings after taxes increased by 30 percent.
a. Compute earnings per share for the year 20X1.
a. Sales ............................................................ $375,0
Cost of goods sold ........................ 246,0
b. Compute earnings per share for the year 20X2.
Gross Profit ........................ $129,0
2-2. Solution:
Sosa Diet Supplements
a. Year 20X1
b. With a gross profit of 34 percent, the firm is outpe
Earnings after taxes industry average of 30 percent.
Earnings per share =
Shares outstanding
4. Operating profit (LO1) A-Rod Fishing Supplies had sales of $2,500,000 and cos
$1,710,000. Selling and administrative expenses represented 10 percent of sal
was 6 percent of the total assets of $4,680,000. What was the firm’s operating
= = $4.00
