Solutions Manual
Complete Solutions
Manual
Corporate Finance
Ross, Westerfield, And Jaffe
12th Edition
,Solutions Manual
CHAPTER 1
INTRODUCTION TO CORPORATE
FINANCE
Answers To Concept Questions
1. In The Corporate Form Of Ownership, The Shareholders Are The Owners Of The Firm. The
Shareholders Elect The Directors Of The Corporation, Who In Turn Appoint The Firm’s Management.
This Separation Of Ownership 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.
2. Such Organizations Frequently Pursue Social Or Political Missions, So Many Different Goals Are
Conceivable. One Goal That Is Often Cited Is Revenue Minimization; I.E., Provide Whatever Goods
And Services 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 The Equity.
3. 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.
4. 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 Behavior, And The Framework Of Stock Valuation Explicitly Includes These. At The
Other Extreme, We Could Argue That These Are Non-Economic Phenomena And Are Best Handled
Through The Political Process. A Classic (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. However, The Firm Believes That Improving The
Safety Of The Product Will Only Save $20 Million In Product Liability Claims. What Should The
Firm Do?”
5. 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.
6. The Goal Of Management Should Be To Maximize The Share Price For The Current Shareholders. If
Management Believes That It Can Improve The Profitability Of The Firm So That The Share
Price Will Exceed $35, 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 They Should Still Fight The Offer. However, If The
Current Management Cannot Increase The Value Of The Firm Beyond The Bid Price, And No Other
Higher Bids Come In, Then Management Is Not Acting In The Interests Of The Shareholders By
Fighting The Offer. Since Current Managers Often Lose
, Their Jobs When The Corporation Is Acquired, Poorly Monitored Managers Have An Incentive
To FightCorporate Takeovers In Situations Such As This.
7. We Would Expect Agency Problems To Be Less Severe In Other Countries, Primarily Due To The
Relatively Small Percentage Of Individual Ownership. Fewer Individual Owners Should Reduce The
Number Of Diverse Opinions Concerning Corporate Goals. The High Percentage Of Institutional
Ownership Might Lead To A Higher Degree Of Agreement Between Owners And Managers On
Decisions Concerning Risky Projects. In Addition, Institutions May Be Better Able To Implement
Effective Monitoring Mechanisms On Managers Than Can Individual Owners, Based On The
Institutions’ Deeper Resources And Experiences With Their Own Management.
8. The Increase In Institutional Ownership Of Stock In The United States And The Growing Activism
Of These Large Shareholder Groups May Lead To A Reduction In Agency Problems For U.S.
Corporations And A More Efficient Market For Corporate Control. However, This May Not Always
Be The Case. If The Managers Of The Mutual Fund Or Pension Plan Are Not Concerned With The
Interests Of The Investors, The Agency Problem Could Potentially Remain The Same, Or Even
Increase Since There Is The Possibility Of Agency Problems Between The Fund And Its Investors.
9. How Much Is Too Much? Who Is Worth More, Larry Ellsion Or Tiger Woods? The Simplest Answer
Is That There Is A Market For Executives Just As There Is For All Types Of Labor. Executive
Compensation Is The Price That Clears The Market. The Same Is True For Athletes And Performers.
Having Said That, One Aspect Of Executive Compensation Deserves Comment. A Primary Reason
Executive Compensation Has Grown So Dramatically Is That Companies Have Increasingly Moved
To Stock-Based Compensation. Such Movement Is Obviously Consistent With The Attempt To Better
Align Stockholder 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 Simply Due To
Rising Stock Prices In General, Not Managerial Performance. Perhaps In The Future, Executive
Compensation Will Be Designed To Reward Only Differential Performance, I.E., Stock Price
Increases In Excess Of General Market Increases.
10. Maximizing The Current Share Price Is The Same As Maximizing The Future Share Price At Any
Future Period. The Value Of A Share Of Stock Depends On All Of The Future Cash Flows Of
Company. Another Way To Look At This Is That, Barring Large Cash Payments To Shareholders,
The Expected Price Of The Stock Must Be Higher In The Future Than It Is Today. Who Would Buy
A Stock For $100 Today When The Share Price In One Year Is Expected To Be $80?
, Solutions Manual
CHAPTER 2
FINANCIAL STATEMENTS AND CASH
FLOW
Answers To Concepts Review And Critical Thinking Questions
1. True. Every Asset Can Be Converted To Cash At Some Price. However, When We Are Referring To
A Liquid Asset, The Added Assumption That The Asset Can Be Quickly Converted To Cash At Or
Near Market Value Is Important.
2. The Recognition And Matching Principles In Financial Accounting Call For Revenues, And The Costs
Associated With Producing Those Revenues, To Be “Booked” When The Revenue Process Is
Essentially Complete, Not Necessarily When The Cash Is Collected Or Bills Are Paid. Note That This
Way Is Not Necessarily Correct; It’s The Way Accountants Have Chosen To Do It.
3. The Bottom Line Number Shows The Change In The Cash Balance On The Balance Sheet. As Such,
It Is NotA Useful Number For Analyzing A Company.
4. The Major Difference Is The Treatment Of Interest Expense. The Accounting Statement Of Cash
Flows Treats Interest As An Operating Cash Flow, While The Financial Cash Flows Treat Interest
As A Financing Cash Flow. The Logic Of The Accounting Statement Of Cash Flows Is That Since
Interest Appears On The Income Statement, Which Shows The Operations For The Period, It Is An
Operating Cash Flow. In Reality, Interest Is A Financing Expense, Which Results From The
Company’s Choice Of Debt And Equity. We Will Have More To Say About This In A Later Chapter.
When Comparing The Two Cash Flow Statements, The Financial Statement Of Cash Flows Is A More
Appropriate Measure Of The Company’s PerformanceBecause Of Its Treatment Of Interest.
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.
6. For A Successful Company That Is Rapidly Expanding, For Example, Capital Outlays Will Be Large,
Possibly Leading To Negative Cash Flow From Assets. In General, What Matters Is Whether The
Money Is Spent Wisely, Not Whether Cash Flow From Assets Is Positive Or Negative.
7. It’s Probably Not A Good Sign For An Established Company To Have Negative Cash Flow From
Operations, But It Would Be Fairly Ordinary For A Start-Up, So It Depends.
Complete Solutions
Manual
Corporate Finance
Ross, Westerfield, And Jaffe
12th Edition
,Solutions Manual
CHAPTER 1
INTRODUCTION TO CORPORATE
FINANCE
Answers To Concept Questions
1. In The Corporate Form Of Ownership, The Shareholders Are The Owners Of The Firm. The
Shareholders Elect The Directors Of The Corporation, Who In Turn Appoint The Firm’s Management.
This Separation Of Ownership 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.
2. Such Organizations Frequently Pursue Social Or Political Missions, So Many Different Goals Are
Conceivable. One Goal That Is Often Cited Is Revenue Minimization; I.E., Provide Whatever Goods
And Services 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 The Equity.
3. 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.
4. 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 Behavior, And The Framework Of Stock Valuation Explicitly Includes These. At The
Other Extreme, We Could Argue That These Are Non-Economic Phenomena And Are Best Handled
Through The Political Process. A Classic (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. However, The Firm Believes That Improving The
Safety Of The Product Will Only Save $20 Million In Product Liability Claims. What Should The
Firm Do?”
5. 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.
6. The Goal Of Management Should Be To Maximize The Share Price For The Current Shareholders. If
Management Believes That It Can Improve The Profitability Of The Firm So That The Share
Price Will Exceed $35, 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 They Should Still Fight The Offer. However, If The
Current Management Cannot Increase The Value Of The Firm Beyond The Bid Price, And No Other
Higher Bids Come In, Then Management Is Not Acting In The Interests Of The Shareholders By
Fighting The Offer. Since Current Managers Often Lose
, Their Jobs When The Corporation Is Acquired, Poorly Monitored Managers Have An Incentive
To FightCorporate Takeovers In Situations Such As This.
7. We Would Expect Agency Problems To Be Less Severe In Other Countries, Primarily Due To The
Relatively Small Percentage Of Individual Ownership. Fewer Individual Owners Should Reduce The
Number Of Diverse Opinions Concerning Corporate Goals. The High Percentage Of Institutional
Ownership Might Lead To A Higher Degree Of Agreement Between Owners And Managers On
Decisions Concerning Risky Projects. In Addition, Institutions May Be Better Able To Implement
Effective Monitoring Mechanisms On Managers Than Can Individual Owners, Based On The
Institutions’ Deeper Resources And Experiences With Their Own Management.
8. The Increase In Institutional Ownership Of Stock In The United States And The Growing Activism
Of These Large Shareholder Groups May Lead To A Reduction In Agency Problems For U.S.
Corporations And A More Efficient Market For Corporate Control. However, This May Not Always
Be The Case. If The Managers Of The Mutual Fund Or Pension Plan Are Not Concerned With The
Interests Of The Investors, The Agency Problem Could Potentially Remain The Same, Or Even
Increase Since There Is The Possibility Of Agency Problems Between The Fund And Its Investors.
9. How Much Is Too Much? Who Is Worth More, Larry Ellsion Or Tiger Woods? The Simplest Answer
Is That There Is A Market For Executives Just As There Is For All Types Of Labor. Executive
Compensation Is The Price That Clears The Market. The Same Is True For Athletes And Performers.
Having Said That, One Aspect Of Executive Compensation Deserves Comment. A Primary Reason
Executive Compensation Has Grown So Dramatically Is That Companies Have Increasingly Moved
To Stock-Based Compensation. Such Movement Is Obviously Consistent With The Attempt To Better
Align Stockholder 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 Simply Due To
Rising Stock Prices In General, Not Managerial Performance. Perhaps In The Future, Executive
Compensation Will Be Designed To Reward Only Differential Performance, I.E., Stock Price
Increases In Excess Of General Market Increases.
10. Maximizing The Current Share Price Is The Same As Maximizing The Future Share Price At Any
Future Period. The Value Of A Share Of Stock Depends On All Of The Future Cash Flows Of
Company. Another Way To Look At This Is That, Barring Large Cash Payments To Shareholders,
The Expected Price Of The Stock Must Be Higher In The Future Than It Is Today. Who Would Buy
A Stock For $100 Today When The Share Price In One Year Is Expected To Be $80?
, Solutions Manual
CHAPTER 2
FINANCIAL STATEMENTS AND CASH
FLOW
Answers To Concepts Review And Critical Thinking Questions
1. True. Every Asset Can Be Converted To Cash At Some Price. However, When We Are Referring To
A Liquid Asset, The Added Assumption That The Asset Can Be Quickly Converted To Cash At Or
Near Market Value Is Important.
2. The Recognition And Matching Principles In Financial Accounting Call For Revenues, And The Costs
Associated With Producing Those Revenues, To Be “Booked” When The Revenue Process Is
Essentially Complete, Not Necessarily When The Cash Is Collected Or Bills Are Paid. Note That This
Way Is Not Necessarily Correct; It’s The Way Accountants Have Chosen To Do It.
3. The Bottom Line Number Shows The Change In The Cash Balance On The Balance Sheet. As Such,
It Is NotA Useful Number For Analyzing A Company.
4. The Major Difference Is The Treatment Of Interest Expense. The Accounting Statement Of Cash
Flows Treats Interest As An Operating Cash Flow, While The Financial Cash Flows Treat Interest
As A Financing Cash Flow. The Logic Of The Accounting Statement Of Cash Flows Is That Since
Interest Appears On The Income Statement, Which Shows The Operations For The Period, It Is An
Operating Cash Flow. In Reality, Interest Is A Financing Expense, Which Results From The
Company’s Choice Of Debt And Equity. We Will Have More To Say About This In A Later Chapter.
When Comparing The Two Cash Flow Statements, The Financial Statement Of Cash Flows Is A More
Appropriate Measure Of The Company’s PerformanceBecause Of Its Treatment Of Interest.
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.
6. For A Successful Company That Is Rapidly Expanding, For Example, Capital Outlays Will Be Large,
Possibly Leading To Negative Cash Flow From Assets. In General, What Matters Is Whether The
Money Is Spent Wisely, Not Whether Cash Flow From Assets Is Positive Or Negative.
7. It’s Probably Not A Good Sign For An Established Company To Have Negative Cash Flow From
Operations, But It Would Be Fairly Ordinary For A Start-Up, So It Depends.
