Solutions Manual l
For
Corporate Finance l
Ross, Westerfield, Jaffe and Jordan
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13th edition l l
Prepared by: l
Brad Jordan l
Joe Smolira
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All Chapters Solutions Manual Supplement files download
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link at the end of this file.
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, CHAPTER 2 - 2
CHAPTER 1 l
INTRODUCTION TO CORPORATE l l
FINANCE
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Answers to Concept Questions l l l
1. In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders electthe
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directors of the corporation, who in turn appoint the firm’s management. This separation of ownership
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from control in the corporate form of organization is what causes agency problems to exist.Management
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may act in its own or someone else’s best interests, rather than those of the shareholders. If such events
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occur, they may contradict the goal of maximizing the share price of the equity of the firm.
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2. Such organizations frequently pursue social or political missions, so many different goals are
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conceivable. One goal that is often cited is revenue minimization; i.e., provide whatever goods and
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services are offered at the lowest possible cost to society. A better approach might be to observe that even
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a not-for-profit business has equity. Thus, one answer is that the appropriate goal is to maximizethe value
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of the equity.
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3. Presumably, the current stock value reflects the risk, timing, and magnitude of all future cash flows, both l l l l l l l l l l l l l l l l
short-term and long-term. If this is correct, then the statement is false.
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4. An argument can be made either way. At the one extreme, we could argue that in a market economy,all of
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these things are priced. There is thus an optimal level of, for example, ethical and/or illegal behavior, and
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the framework of stock valuation explicitly includes these. At the other extreme, we could argue that these
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are non-economic phenomena and are best handled through the political process. A classic (and highly
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relevant) thought question that illustrates this debate goes something like this: “A firm has estimated that
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the cost of improving the safety of one of its products is $30 million. However, the firm believes that
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improving the safety of the product will only save $20 million in product liability claims. What should
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the firm do?”
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5. The goal will be the same, but the best course of action toward that goal may be different because of
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differing social, political, and economic institutions.
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6. The goal of management should be to maximize the share price for the current shareholders. If
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management believes that itcan improve the profitability of thefirmso that the share price will exceed
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$35, then they should fight the offer from the outside company. If management believes that this bidder,
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or other unidentified bidders, will actually pay more than $35 per share to acquire the company, then they
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should still fight the offer. However, if the current management cannot increase the value of the firm
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beyond the bid price, and no other higher bids come in, then management is not acting in theinterests of
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the shareholders by fighting the offer. Since current managers often lose their jobs when the corporation
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is acquired, poorly monitored managers have an incentive to fight corporate takeoversin situations such as
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this.
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, CHAPTER 2 - 3
7. We would expect agency problems to be less severe in other countries, primarily due to the relatively
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small percentage of individual ownership. Fewer individual owners should reduce the number of diverse
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opinions concerning corporate goals. The high percentage of institutional ownership might lead to a
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higher degree of agreement between owners and managers on decisions concerning risky projects. In
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addition, institutions may be better able to implement effective monitoring mechanisms on managers
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than can individual owners, based on the institutions’ deeper resources and experiences with their own
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management.
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8. The increase in institutional ownership of stock in the United States and the growing activism of theselarge
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shareholder groups may lead to a reduction in agency problems for U.S. corporations and a moreefficient
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market for corporate control. However, this may not always be the case. If the managers of the mutual
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fund or pension plan are not concerned with the interests of the investors, the agency problem could
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potentially remain the same, or even increase, since there is the possibility of agency problems between
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the fund and its investors.
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9. How much is too much? Who is worth more, Larry Ellison or Tiger Woods? The simplest answer is that
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there is a market for executives just as there is for all types of labor. Executive compensation is the price
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that clears the market. The same is true for athletes and performers. Having said that, one aspect of
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executive compensation deserves comment. A primary reason executive compensation has grown so
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dramatically is that companies have increasingly moved to stock-based compensation. Suchmovement is
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obviously consistent with the attempt to better align stockholder and management interests. In recent
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years, stock prices have soared, so management has cleaned up. It is sometimes argued that much of this
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reward is due to rising stock prices in general, not managerial performance. Perhaps in the future,
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executive compensation will be designed to reward only differential performance, i.e., stock price
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increases in excess of general market increases.
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10. Maximizing the current share price is the same as maximizing the future share price at any future period. l l l l l l l l l l l l l l l l l
The value of a share of stock depends on all of the future cash flows of company. Another wayto look at this
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is that, barring large cash payments to shareholders, the expected price of the stock must be higher in the
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future than it is today. Who would buy a stock for $100 today when the share price inone year is expected
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to be $80?
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, CHAPTER 2 l
FINANCIAL STATEMENTS AND CASH l l l
FLOW
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Answers to Concepts Review and Critical Thinking Questions
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1. True. Every asset can be converted to cash at some price. However, when we are referring to a liquid
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asset, the added assumption that the asset can be quickly converted to cash at or near market value is
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important.
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2. The recognition and matching principles in financial accounting call for revenues, and the costs
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associated with producing those revenues, to be “booked” when the revenue process is essentially
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complete, not necessarily when the cash is collected or bills are paid. Note that this way is not necessarily
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correct; it’s the way accountants have chosen to do it.
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3. The bottom line number shows the change in the cash balance on the balance sheet. As such, it is not a
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useful number for analyzing a company.
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4. The major difference is the treatment of interest expense. The accounting statement of cash flows treats
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interest as an operating cash flow, while the financial cash flows treat interest as a financing cash flow.
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The logic of the accounting statement of cash flows is that since interest appears on the income
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statement, which shows the operations for the period, it is an operating cash flow. In reality, interest is a
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financing expense, which results from the company’s choice of debt and equity. We will have more to
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say about this in a later chapter. When comparing the two cash flow statements, the financial statement of
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cashflowsisa moreappropriatemeasureofthecompany’sperformancebecauseof its treatment of interest.
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5. Market values can never be negative. Imagine a share of stock selling for –$20. This would mean that if
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you placed an order for 100 shares, you would get the stock along with a check for $2,000. How many
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shares do you want to buy? More generally, because of corporate and individual bankruptcy laws, net
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worth for a person or a corporation cannot be negative, implying that liabilities cannot exceed assets in
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market value.
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6. For a successful company that is rapidly expanding, for example, capital outlays will be large, possibly
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leading to negative cash flow from assets. In general, what matters is whether the money is spent wisely,
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not whether cash flow from assets is positive or negative.
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7. It’s probably not a good sign for an established company to have negative cash flow from operations,but it
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would be fairly ordinary for a start-up, so it depends.
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