, CHAPTER il1
Introduction ilto ilCorporate ilFinance
The ilvalues ilshown ilin ilthe ilsolutions ilmay ilbe ilrounded ilfor ildisplay ilpurposes. ilHowever, ilthe ilanswers
ilwereid
l erived ilusing ila ilspreadsheet ilwithout ilany ilintermediate ilrounding.
Answers ilto ilProblem ilSets
1. a. real
b. executive ilairplanes
c. brand ilnames
d. financial
e. bonds
*f. investment ilor ilcapital ilexpenditure
*g. capital ilbudgeting ilor ilinvestment
h. financing
*Note ilthat ilf iland ilg ilare ilinterchangeable ilin ilthe ilquestion.
Est iltime: il01-05
2. A iltrademark, ila ilfactory, ilundeveloped illand, iland ilyour ilwork ilforce il(c, ild, ile, iland ilg) ilare ilall
ilreal ilassets. ilReal ilassets ilare ilidentifiable ilas ilitems ilwith ilintrinsic ilvalue. ilThe ilothers ilin ilthe
illist ilare ilfinancial ilassets,itl hat ilis, ilthese ilassets ilderive ilvalue ilbecause ilof ila ilcontractual
ilclaim.
Est iltime: il01-05
3. a. Financial ilassets, ilsuch ilas ilstocks ilor ilbank illoans, ilare ilclaims ilheld ilby ilinvestors.
ilCorporations ilsell ilfinancial ilassets ilto ilraise ilthe ilcash ilto ilinvest ilin ilreal ilassets
ilsuch ilas ilplantia
l nd ilequipment. ilSome ilreal ilassets ilare ilintangible.
b. Capital ilexpenditure ilmeans ilinvestment ilin ilreal ilassets. ilFinancing ilmeans ilraising
ilthe il cashilfor ilthis ilinvestment.
c. The ilshares ilof ilpublic ilcorporations ilare iltraded ilon ilstock ilexchanges iland ilcan ilbe
ilpurchasedb il y ila ilwide ilrange ilof ilinvestors. ilThe ilshares ilof ilclosely ilheld ilcorporations
ilare ilnot il publicly iltraded iland ilare ilheld ilby ila ilsmall ilgroup ilof ilprivate ilinvestors.
d. Unlimited illiability: ilInvestors ilare ilresponsible ilfor ilall ilthe ilfirm‘s ildebts. ilA ilsole
ilproprietor ilhasu
il nlimited illiability. ilInvestors ilin ilcorporations ilhave illimited illiability.
ilThey ilcan illose iltheir ilinvestment, ilbut ilno ilmore.
Est iltime: il01-05
,4. Items ilc iland ild ilapply ilto ilcorporations. ilBecause ilcorporations ilhave ilperpetual illife,
ilownership ilcan ilbetil ransferred ilwithout ilaffecting iloperations, iland ilmanagers ilcan ilbe ilfired
ilwith ilno ileffect ilon ilownership. ilOther ilforms ilof ilbusiness ilmay ilhave ilunlimited illiability iland
illimited illife.
Est iltime: il01-05
5. Separation ilof ilownership ilfacilitates ilthe ilkey ilattributes ilof ila ilcorporation, ilincluding il limited
illiability ilforil nvestors, iltransferability ilof ilownership, ila ilseparate illegal ilpersonality ilof ilthe
ilcorporation, iland ildelegated ilcentralized ilmanagement. ilThese ilfour ilattributes ilprovide
ilsubstantial ilbenefit ilfor ilinvestors, ilincluding ilthe il ability ilto il diversify iltheir ilinvestment
il among il many iluncorrelated ilreturns—a ilvery ilvaluable iltool ilexplored ilin illater ilchapters. ilAlso,
ilthese ilattributes ilallow ilinvestors ilto ilquickly ilexit,ie
l nter, ilor ilshort ilsell ilan ilinvestment, ilthereby
ilgenerating ilan ilactive illiquid ilmarket ilfor ilcorporations.
However, ilthese ilpositive ilaspects ilalso ilintroduce ilsubstantial ilnegative ilexternalities ilas ilwell.
i l The ilseparation ilof ilownership ilfrom ilmanagement iltypically illeads ilto ilagency ilproblems,
ilwhere ilmanagersip l refer ilto ilconsume ilprivate ilperks il or ilmake ilother ildecisions ilfor iltheir
ilprivate ilbenefit—rather ilthan ilmaximize ilshareholder ilwealth. ilShareholders iltend ilto ilexercise
illess iloversight ilof ileach ilindividual ilinvestment ilas iltheir ildiversification ilincreases. ilFinally, ilthe
ilcorporation‘s ilseparate illegal ilpersonalityim l akes ilit ildifficult ilto ilenforce ilaccountability ilif ilthey
ilexternalize ilcosts ilonto ilsociety.
Est iltime: il01-05
6. Shareholders ilwill ilonly ilvote ilto ilmaximize ilshareholder ilwealth. ilShareholders ilcan ilmodify
iltheir ilpattern ilof ilconsumption ilthrough ilborrowing iland illending, ilmatch ilrisk ilpreferences,
iland ilhopefullyib l alance iltheir ilown ilcheckbooks il(or ilhire ila ilqualified ilprofessional ilto ilhelp
ilthem ilwith ilthese iltasks).
Est iltime: il01-05
7. If ilthe ilinvestment ilincreases ilthe ilfirm‘s ilwealth, ilit ilincreases ilthe ilfirm‘s ilshare ilvalue. ilMs.
ilEspinozac il ould ilthen ilsell ilsome ilor ilall ilthese ilmore ilvaluable ilshares ilto ilprovide ilfor ilher
ilretirement ilincome.
Est iltime: il01-05
8. a. Assuming ilthat ilthe ilencabulator ilmarket ilis ilrisky, ilan il8% ilexpected
ilreturn ilonitl he ilF&H ilencabulator ilinvestments ilmay ilbe ilinferior ilto ila
il4% ilreturn ilon ilU.S.
government ilsecurities, ildepending ilon ilthe ilrelative ilrisk ilbetween ilthe iltwo ilassets.
b. Unless ilthe ilfinancial ilassets ilare ilas ilsafe ilas ilU.S. ilgovernment ilsecurities, iltheir ilcost
il of ilcapitalw
il ould ilbe ilhigher. ilThe ilCFO ilcould ilconsider ilexpected ilreturns ilon ilassets
ilwith ilsimilar ilrisk.
Est iltime: il06-10
9. Managers ilwould ilact ilin ilshareholders‘ ilinterests ilbecause ilthey ilhave ila illegal ilduty ilto ilact ilin
iltheir ilinterests. il Managers ilmay ilalso ilreceive ilcompensation— ilbonuses, ilstock, iland iloption
ilpayouts il with ilvalue iltied il(roughly) ilto ilfirm ilperformance. ilManagers ilmay ilfear ilpersonal
ilreputational ildamage ilfrom ilnot ilacting ilin ilshareholders‘ ilinterests. ilAnd ilmanagers ilcan ilbe
, ilfired ilby ilthe ilboard ilof ildirectors il(electedilby ilshareholders). i l If ilmanagers ilstill ilfail ilto ilact ilin
ilshareholders‘ ilinterests, ilshareholders ilmay ilsell iltheir ilshares, illowering ilthe ilstock ilprice iland
ilpotentially ilcreating ilthe ilpossibility ilof ila iltakeover, ilwhich ilcan ilagain illead ilto ilchanges ilin
ilthe ilboard ilof ildirectors iland ilsenior ilmanagement.
Est iltime: il01-05
