Parrino et al. Fundamentals of Corporate Finance, 5th edition Solutions Manual
SolutionManualfor n n
Fundamentals of Corporate Finance, 5th Edition by Robert Parrino, David Kidwell,
n n n n n n n n n n
Bates & Gillan. ISBN 9781119795438
n n n n n
Chapter 1-21 n
Copyright © 2022 John Wiley & Sons, Inc. SM 4-
, Parrino et al. Fundamentals of Corporate Finance, 5th edition Solutions Manual
Chapter 1 n
TheFinancialManagerandthe Firm n n n n n
BeforeYouGo OnQuestionsand Answers
n n n n n n
Section1.1 n
1. What are the three basic types of financial decisions managers must make?
n n n n n n n n n n n
The three basic decisions each business must make are the capital budgeting decision, the
n n n n n n n n n n n n n
n financing decision, and the workingcapital management decision. These decisions determine
n n n n n n n n n n
n which productive assets to buy, how to pay for or finance these purchases, and how to manage the
n n n n n n n n n n n n n n n n n
n day-to-day financial matters so the company can pay its bills.n n n n n n n n n
2. Explain why you would make an investment if the value of the expected cash
n n n n n n n n n n n n n
n flows exceeds the cost of the project.
n n n n n n
You would accept an investment project whose cash flows exceed the cost of the project because
n n n n n n n n n n n n n n n
n such projects will increase the value of the firm, making the owners wealthier. Most people start a
n n n n n n n n n n n n n n n n
business to increase their wealth. Remember that the cost of capital (time value of money) will
n n n n n n n n n n n n n n n n
n affect the decision about whether to invest.
n n n n n n
3. Why are capital budgeting decisions among the most important decisions in the life of a
n n n n n n n n n n n n n n
n firm?
The capital budgeting decisions are considered the most important in the life of the firm because
n n n n n n n n n n n n n n n
n these decisions determine which productive assets the firm purchases, and which assets generate
n n n n n n n n n n n n
most of the firm’s cash flows. Furthermore, capital budgeting decisions are
n n n n n n n n n n n
Copyright © 2022 John Wiley & Sons, Inc. SM 4-
,Parrino et al. Fundamentals of Corporate Finance, 5th edition Solutions Manual
long-term decisions and if you make a mistake in selecting a productive asset, you are stuck with
n n n n n n n n n n n n n n n n
n the decision for a long time.
n n n n n
Section1.2 n
1. Why are many businesses operated as sole proprietorships or partnerships?
n n n n n n n n n
Many businesses elect to operate as sole proprietorships or partnerships because of the small
n n n n n n n n n n n n n
n operating scale and capital base of their firms. Both of these forms of business organization are
n n n n n n n n n n n n n n n
n fairly easy to start and impose few regulations on the owners.
n n n n n n n n n n
2. What are some advantages and disadvantages of operating as a public corporation? The
n n n n n n n n n n n n
n main advantages of operating as a public corporation are the access to the public securities
n n n n n n n n n n n n n n
n markets, which makes it easier to raise large amounts of capital, and the ease of ownership
n n n n n n n n n n n n n n n
transfer. All the shareholders have to do is to call their broker to buy or sell shares of stock. Since a
n n n n n n n n n n n n n n n n n n n n n
n public corporation usually has many shares outstanding, large blocks of securities can be
n n n n n n n n n n n n
n purchased or sold without an appreciable impact on the price of the stock. The major
n n n n n n n n n n n n n n
n disadvantage of corporations is the tax situation. Not only must the corporation pay taxes on its
n n n n n n n n n n n n n n n
n income, but the owners of the corporation get taxed again when dividends are paid to them. This
n n n n n n n n n n n n n n n n
n is referred to as double taxation. In addition to taxes, public corporations are subject to stringent
n n n n n n n n n n n n n n n
reporting requirements, and the incentives may convince managers to focus on shorter-term
n n n n n n n n n n n n
n profitability than longer-term wealth creation. n n n n
3. Explain why professional partnerships such as physicians’ groups organize as limited
n n n n n n n n n n
n liability partnerships. n
Professional partnerships such as physicians’ groups desire to organize as limited liability
n n n n n n n n n n n
n partnerships (LLPs) to take advantage of the tax arrangements of partnerships combined with the
n n n n n n n n n n n n n
n advantages of the limited liability of a corporation. By operating as an LLP, the partnership is
n n n n n n n n n n n n n n n
able to avoid a potential financial disaster resulting from the misconduct of one partner.
n n n n n n n n n n n n n n
Section1.3 n
1. What are the major responsibilities of the CFO?
n n n n n n n
Copyright © 2022 John Wiley & Sons, Inc. SM 4-
, Parrino et al. Fundamentals of Corporate Finance, 5th edition Solutions Manual
The major responsibilities of a CFO include analysis and recommendations for financial
n n n n n n n n n n n
n decisions. The CFO, who reports directly to the CEO, focuses on managing all aspects of the
n n n n n n n n n n n n n n n
n firm’s finances and works with the CEO on strategic issues. The CFO also interacts with staff
n n n n n n n n n n n n n n n
n in other functional areas on a regular basis related to financial issues that affect the business.
n n n n n n n n n n n n n n n
2. Identify the financial officers who typically report to the CFO and describe their duties. The
n n n n n n n n n n n n n n
n financial officers discussed in the chapter who report to the CFO are the controller, the treasurer,
n n n n n n n n n n n n n n n
n the risk manager, and the internal auditor.
n n n n n n
The controller is the firm’s chief accounting officer, and thus prepares the financial statements
n n n n n n n n n n n n n
and taxes. This position also requires close cooperation with the external auditors. The treasurer’s
n n n n n n n n n n n n n n
n responsibility is the collection and disbursement of cash, investing excess cash, raising new
n n n n n n n n n n n n
n capital, handling foreign exchange, and overseeing the company’s pension fund management.
n n n n n n n n n n
n This individual also assists the CFO in handling important Wall Street relationships. The risk
n n n n n n n n n n n n n
n manager monitors and manages the firm’s risk exposure in financial and commodity markets
n n n n n n n n n n n n
n and the firm’s relationships with insurance providers. Finally, the internal auditor is responsible
n n n n n n n n n n n n
n for conducting risk assessment and performing audits of high- risk areas.
n n n n n n n n n n
3. Why does the internal auditor report to both the CFO and the audit committee of the
n n n n n n n n n n n n n n n
n board of directors? n n
The internal auditor reports to the CFO on a day-to-day basis but is ultimately accountable for
n n n n n n n n n n n n n n n
n reporting any accounting irregularities to the board of directors. The dual reporting system
n n n n n n n n n n n n
serves as a check to ensure that there are no discrepancies in the company’s financial statements.
n n n n n n n n n n n n n n n n
Section1.4 n
1. Why is profit maximization an unsatisfactory goal for managing a firm?
n n n n n n n n n n
Profit maximization is not a satisfactory goal when managing a firm because it is rather difficult to
n n n n n n n n n n n n n n n n
define profits since accountants can apply and interpret the same accounting
n n n n n n n n n n n
Copyright © 2022 John Wiley & Sons, Inc. SM 4-
SolutionManualfor n n
Fundamentals of Corporate Finance, 5th Edition by Robert Parrino, David Kidwell,
n n n n n n n n n n
Bates & Gillan. ISBN 9781119795438
n n n n n
Chapter 1-21 n
Copyright © 2022 John Wiley & Sons, Inc. SM 4-
, Parrino et al. Fundamentals of Corporate Finance, 5th edition Solutions Manual
Chapter 1 n
TheFinancialManagerandthe Firm n n n n n
BeforeYouGo OnQuestionsand Answers
n n n n n n
Section1.1 n
1. What are the three basic types of financial decisions managers must make?
n n n n n n n n n n n
The three basic decisions each business must make are the capital budgeting decision, the
n n n n n n n n n n n n n
n financing decision, and the workingcapital management decision. These decisions determine
n n n n n n n n n n
n which productive assets to buy, how to pay for or finance these purchases, and how to manage the
n n n n n n n n n n n n n n n n n
n day-to-day financial matters so the company can pay its bills.n n n n n n n n n
2. Explain why you would make an investment if the value of the expected cash
n n n n n n n n n n n n n
n flows exceeds the cost of the project.
n n n n n n
You would accept an investment project whose cash flows exceed the cost of the project because
n n n n n n n n n n n n n n n
n such projects will increase the value of the firm, making the owners wealthier. Most people start a
n n n n n n n n n n n n n n n n
business to increase their wealth. Remember that the cost of capital (time value of money) will
n n n n n n n n n n n n n n n n
n affect the decision about whether to invest.
n n n n n n
3. Why are capital budgeting decisions among the most important decisions in the life of a
n n n n n n n n n n n n n n
n firm?
The capital budgeting decisions are considered the most important in the life of the firm because
n n n n n n n n n n n n n n n
n these decisions determine which productive assets the firm purchases, and which assets generate
n n n n n n n n n n n n
most of the firm’s cash flows. Furthermore, capital budgeting decisions are
n n n n n n n n n n n
Copyright © 2022 John Wiley & Sons, Inc. SM 4-
,Parrino et al. Fundamentals of Corporate Finance, 5th edition Solutions Manual
long-term decisions and if you make a mistake in selecting a productive asset, you are stuck with
n n n n n n n n n n n n n n n n
n the decision for a long time.
n n n n n
Section1.2 n
1. Why are many businesses operated as sole proprietorships or partnerships?
n n n n n n n n n
Many businesses elect to operate as sole proprietorships or partnerships because of the small
n n n n n n n n n n n n n
n operating scale and capital base of their firms. Both of these forms of business organization are
n n n n n n n n n n n n n n n
n fairly easy to start and impose few regulations on the owners.
n n n n n n n n n n
2. What are some advantages and disadvantages of operating as a public corporation? The
n n n n n n n n n n n n
n main advantages of operating as a public corporation are the access to the public securities
n n n n n n n n n n n n n n
n markets, which makes it easier to raise large amounts of capital, and the ease of ownership
n n n n n n n n n n n n n n n
transfer. All the shareholders have to do is to call their broker to buy or sell shares of stock. Since a
n n n n n n n n n n n n n n n n n n n n n
n public corporation usually has many shares outstanding, large blocks of securities can be
n n n n n n n n n n n n
n purchased or sold without an appreciable impact on the price of the stock. The major
n n n n n n n n n n n n n n
n disadvantage of corporations is the tax situation. Not only must the corporation pay taxes on its
n n n n n n n n n n n n n n n
n income, but the owners of the corporation get taxed again when dividends are paid to them. This
n n n n n n n n n n n n n n n n
n is referred to as double taxation. In addition to taxes, public corporations are subject to stringent
n n n n n n n n n n n n n n n
reporting requirements, and the incentives may convince managers to focus on shorter-term
n n n n n n n n n n n n
n profitability than longer-term wealth creation. n n n n
3. Explain why professional partnerships such as physicians’ groups organize as limited
n n n n n n n n n n
n liability partnerships. n
Professional partnerships such as physicians’ groups desire to organize as limited liability
n n n n n n n n n n n
n partnerships (LLPs) to take advantage of the tax arrangements of partnerships combined with the
n n n n n n n n n n n n n
n advantages of the limited liability of a corporation. By operating as an LLP, the partnership is
n n n n n n n n n n n n n n n
able to avoid a potential financial disaster resulting from the misconduct of one partner.
n n n n n n n n n n n n n n
Section1.3 n
1. What are the major responsibilities of the CFO?
n n n n n n n
Copyright © 2022 John Wiley & Sons, Inc. SM 4-
, Parrino et al. Fundamentals of Corporate Finance, 5th edition Solutions Manual
The major responsibilities of a CFO include analysis and recommendations for financial
n n n n n n n n n n n
n decisions. The CFO, who reports directly to the CEO, focuses on managing all aspects of the
n n n n n n n n n n n n n n n
n firm’s finances and works with the CEO on strategic issues. The CFO also interacts with staff
n n n n n n n n n n n n n n n
n in other functional areas on a regular basis related to financial issues that affect the business.
n n n n n n n n n n n n n n n
2. Identify the financial officers who typically report to the CFO and describe their duties. The
n n n n n n n n n n n n n n
n financial officers discussed in the chapter who report to the CFO are the controller, the treasurer,
n n n n n n n n n n n n n n n
n the risk manager, and the internal auditor.
n n n n n n
The controller is the firm’s chief accounting officer, and thus prepares the financial statements
n n n n n n n n n n n n n
and taxes. This position also requires close cooperation with the external auditors. The treasurer’s
n n n n n n n n n n n n n n
n responsibility is the collection and disbursement of cash, investing excess cash, raising new
n n n n n n n n n n n n
n capital, handling foreign exchange, and overseeing the company’s pension fund management.
n n n n n n n n n n
n This individual also assists the CFO in handling important Wall Street relationships. The risk
n n n n n n n n n n n n n
n manager monitors and manages the firm’s risk exposure in financial and commodity markets
n n n n n n n n n n n n
n and the firm’s relationships with insurance providers. Finally, the internal auditor is responsible
n n n n n n n n n n n n
n for conducting risk assessment and performing audits of high- risk areas.
n n n n n n n n n n
3. Why does the internal auditor report to both the CFO and the audit committee of the
n n n n n n n n n n n n n n n
n board of directors? n n
The internal auditor reports to the CFO on a day-to-day basis but is ultimately accountable for
n n n n n n n n n n n n n n n
n reporting any accounting irregularities to the board of directors. The dual reporting system
n n n n n n n n n n n n
serves as a check to ensure that there are no discrepancies in the company’s financial statements.
n n n n n n n n n n n n n n n n
Section1.4 n
1. Why is profit maximization an unsatisfactory goal for managing a firm?
n n n n n n n n n n
Profit maximization is not a satisfactory goal when managing a firm because it is rather difficult to
n n n n n n n n n n n n n n n n
define profits since accountants can apply and interpret the same accounting
n n n n n n n n n n n
Copyright © 2022 John Wiley & Sons, Inc. SM 4-
