This document contains the answers to the homework exercises of week 1 for Finance 1. This course is taught at the University of Amsterdam by Jeroen Ligterink and Pepijn Trietsch.
Introduction
In order to prepare for the tutorial, please read the relevant sections of the book and watch the
supporting Canvas videos and then answer the questions below. For tutorial preparation and the
bonus, your answers need to be reasonable but do not have to be completely correct. Start working
on each problem set before the lecture takes place as there is very little time between the end of
the lecture and the deadline for handing in the problem set. The book and supporting videos
should allow you to formulate reasonable answers to most questions before the lecture.
Chapter 1: The Corporation
Read chapter 1 from the book (see Canvas week 1 page for which sections or topics in the chapter
are not part of the material) and read the relevant week 1 lecture slides (if available). Then
answer question 1 below.
1) Consider the following questions about what the corporation is trying to achieve.
a. What is the objective of the firm?
The objective of the firm according to Berk DeMarzo is to maximize shareholder value
b. Name two advantages and two disadvantages of using this objective.
Advantage 1: clear objective (clearly defined number available in the stock market)
Advantage 2: smart price: share price determined in competitive market using a lot of
information and provides a clear trade-off between different moments in time (as it is all
about the effect on current value)
Disadvantage 1: a higher share price might not be good for all stakeholders. This happens
when contracts are not sufficiently complete and some externalities are not taken into
account when determining market prices. In that case certain actions by the firm can be
wealth decreasing for society (consider environmental pollution, massive layoffs, etc.)
Disadvantage 2: separation between ownership and control may give managers leeway to
deviate from this objective and act in their own interest (agency costs)
Disadvantage 3: stock markets may no give a correct representation of value (i.e. bubble).
See later chapters on this.
c. What mechanisms exist that push managers to act in the interests of shareholders?
Describe at least 2 mechanisms.
- Shareholders can tie the compensation of managers to (share) performance
- Shareholders can install boards overlooking management
- Stock market; stock prices will go down if managers do not act in the interest of
shareholders, this may invite a (hostile) takeover (as they see possibility for making
the firm more efficient again, bringing prices back to higher level)
Not mentioned in the book but still very important other mechanisms:
- Competition on product markets (more competition gives less leeway for
managerialism otherwise firm should go bankrupt).
Chapter 2: Financial Statement Analysis
Read chapter 2 of the book and the available lecture slides. Then answer question 2 below.
2) At the beginning of 2017, Coca-Cola (ticker KO) had a book value of equity of $23.1 billion,
4.345 billion shares outstanding, and a market price of $41.74 per share. KO also had cash
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