CHAPTER z1
Introduction zto zCorporate zFinance
The zvalues zshown zin zthe zsolutions zmay zbe zrounded zfor zdisplay zpurposes. zHowever, zthe zanswers
zwerezderived zusing za zspreadsheet zwithout zany zintermediate zrounding.
Answers zto zProblem zSets
1. a. real
b. executive zairplanes
c. brand znames
d. financial
e. bonds
*f. investment zor zcapital zexpenditure
*g. capital zbudgeting zor zinvestment
h. financing
*Note zthat zf zand zg zare zinterchangeable zin zthe zquestion.
Est ztime: z01-05
2. A ztrademark, za zfactory, zundeveloped zland, zand z your zwork zforce z(c, zd, ze, zand zg) zare zall
zreal zassets. zReal zassets zare zidentifiable zas zitems zwith zintrinsic zvalue. zThe zothers zin zthe
zlist zare zfinancial zassets,zthat zis, zthese zassets zderive zvalue zbecause z of za zcontractual
zclaim.
Est ztime: z01-05
3. a. Financial zassets, zsuch zas zstocks zor zbank zloans, zare zclaims zheld zby z investors.
zCorporations zsell zfinancial zassets zto zraise zthe zcash zto zinvest zin zreal zassets
zsuch zas zplantzand zequipment. zSome zreal zassets zare zintangible.
b. Capital zexpenditure zmeans zinvestment zin zreal zassets. zFinancing zmeans zraising
zthe z cashzfor zthis zinvestment.
c. The zshares zof zpublic zcorporations zare ztraded zon zstock zexchanges zand zcan zbe
zpurchasedzby za zwide zrange zof zinvestors. zThe zshares zof zclosely zheld
zcorporations zare znot z publicly ztraded zand zare z held zby za zsmall zgroup zof zprivate
zinvestors.
d. Unlimited zliability: zInvestors zare zresponsible zfor zall zthe zfirm‘s zdebts. zA zsole
zproprietor zhaszunlimited zliability. zInvestors zin zcorporations zhave zlimited zliability.
zThey zcan zlose ztheir zinvestment, zbut zno zmore.
Est ztime: z01-05
,4. Items zc zand zd zapply zto zcorporations. z Because zcorporations zhave zperpetual zlife,
zownership zcan zbeztransferred zwithout zaffecting zoperations, zand zmanagers zcan zbe zfired
zwith zno zeffect zon zownership. zOther zforms zof zbusiness zmay zhave zunlimited zliability zand
zlimited zlife.
Est ztime: z01-05
5. Separation zof zownership zfacilitates zthe zkey zattributes zof za zcorporation, zincluding z limited
zliability zforzinvestors, ztransferability zof zownership, za zseparate zlegal zpersonality zof zthe
zcorporation, zand zdelegated zcentralized zmanagement. zThese zfour zattributes zprovide
zsubstantial zbenefit zfor zinvestors, z including z the z ability zto z diversify ztheir z investment
z among z many zuncorrelated z returns—a zvery zvaluable ztool zexplored zin zlater zchapters. zAlso,
zthese zattributes zallow zinvestors zto zquickly zexit,zenter, zor zshort zsell zan zinvestment,
zthereby zgenerating zan zactive zliquid zmarket zfor zcorporations.
However, zthese zpositive zaspects zalso zintroduce zsubstantial znegative zexternalities zas zwell.
z The zseparation zof zownership zfrom zmanagement ztypically zleads zto zagency zproblems,
zwhere zmanagerszprefer z to z consume z private z perks z or zmake z other z decisions z for z their
z private z benefit—rather z than zmaximize zshareholder zwealth. z Shareholders ztend zto zexercise
zless zoversight zof zeach zindividual zinvestment zas ztheir zdiversification zincreases. zFinally,
zthe zcorporation‘s zseparate zlegal zpersonalityzmakes zit zdifficult zto zenforce zaccountability zif
zthey z externalize zcosts zonto zsociety.
Est ztime: z01-05
6. Shareholders zwill zonly zvote zto zmaximize zshareholder zwealth. zShareholders zcan
zmodify ztheir zpattern zof zconsumption zthrough zborrowing zand zlending, zmatch zrisk
zpreferences, zand zhopefullyzbalance ztheir zown zcheckbooks z(or zhire za zqualified
zprofessional zto zhelp zthem z with zthese ztasks).
Est ztime: z01-05
7. If zthe zinvestment zincreases zthe zfirm‘s zwealth, zit zincreases zthe zfirm‘s zshare zvalue. zMs.
zEspinozazcould zthen zsell zsome zor zall zthese zmore zvaluable zshares zto zprovide zfor zher
zretirement zincome.
Est ztime: z01-05
8. a. Assuming zthat zthe zencabulator zmarket zis zrisky, zan z8% zexpected
zreturn zonzthe zF&H zencabulator zinvestments zmay zbe zinferior zto za
z4% zreturn zon zU.S.
government zsecurities, zdepending zon zthe zrelative zrisk zbetween zthe ztwo zassets.
b. Unless zthe zfinancial zassets zare zas zsafe zas zU.S. zgovernment zsecurities, ztheir zcost
z of zcapitalzwould zbe zhigher. zThe zCFO z could zconsider zexpected zreturns zon zassets
zwith zsimilar zrisk.
Est ztime: z06-10
9. Managers zwould zact zin zshareholders‘ zinterests z because zthey zhave za zlegal zduty zto zact zin
ztheir zinterests. z Managers z may zalso z receive z compensation— z bonuses, z stock, z and z option
z payouts z with zvalue ztied z(roughly) zto zfirm zperformance. zManagers zmay zfear zpersonal
zreputational zdamage zfrom znot zacting zin zshareholders‘ zinterests. zAnd zmanagers zcan zbe
, zfired zby zthe zboard zof zdirectors z (electedzby zshareholders). z If zmanagers z still zfail zto zact zin
zshareholders‘ zinterests, zshareholders zmay zsell ztheir zshares, zlowering zthe zstock zprice zand
zpotentially zcreating zthe zpossibility zof za ztakeover, zwhich zcan zagain zlead zto zchanges zin
zthe zboard zof zdirectors zand z senior zmanagement.
Est ztime: z01-05
, 10. Managers zthat zare zinsulated zfrom z takeovers zmay zbe zmore zprone zto zagency zproblems
zand ztherefore zmore zlikely zto zact zin ztheir zown zinterests zrather zthan zin zshareholders‘. zIf
za zfirm zinstituted zaznew ztakeover zdefense, zwe z might zexpect zto zsee zthe zvalue zof zits
zshares zdecline zas zagency zproblems zincrease zand zless zshareholder zvalue zmaximization
zoccurs. zThe zcounterargument zis zthatzdefensive zmeasures zallow zmanagers zto znegotiate
zfor za zhigher zpurchase zprice zin zthe zface zof za ztakeover zbid—to zthe zbenefit zof
z shareholder z value.
Est ztime: z01-05
Appendix zQuestions:
1. Both zwould zstill zinvest zin ztheir zfriend‘s zbusiness. z A zinvests zand zreceives z$121,000
zfor zhis zinvestment z at z the z end z of z the z year—which z is z greater z than z the z $120,000
z that z would z be z receivedzfrom zlending zat z20% z($100,000 z× z1.20 z= z$120,000). z zG
zalso zinvests, zbut zborrows zagainst zthe
$121,000 zpayment, zand zthus zreceives z$100,833 z($121,000 z/ z1.20) ztoday.
Est ztime: z01-05
2. a. zHe zcould zconsume zup zto z $200,000 znow z(forgoing zall zfuture zconsumption) zor zup zto
z$216,000 znext zyear z($200,000 z× z1.08, zforgoing zall zconsumption zthis zyear). zHe zshould
zinvest zall zof zhis zwealthzto zearn z$216,000 znext z year. z To zchoose zthe zsame zconsumption
z(C) zin zboth zyears, z C z= z($200,000
– zC) z× z1.08 z= z$103,846.
Dollars zNext zYear
220,000
216,000
203,704
200,000
Dollars zNow
b. zHe zshould zinvest zall zof zhis zwealth z to zearn z$220,000 z($200,000 z× z1.10) znext zyear.
z If zhe zconsumes zall zthis zyear, zhe zcan znow zhave za ztotal zof z$203,703.70 z($200,000 z×
z1.10/1.08) zthis z yearzor z$220,000 znext zyear. z If zhe zconsumes zC zthis zyear, zthe zamount
zavailable zfor znext z year‘s zconsumption zis z($203,703.70 z– zC) z× z1.08. z To zget zequal
zconsumption zin zboth z years, zset zthe zamount zconsumed ztoday zequal zto zthe zamount
znext z year:
C z= z($203,703.70 z– zC) z× z1.08
C z= z$105,769.20
Est ztime: z06-10
