Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
CHAPTER 1
INTRODUCTION TO CORPORATE
FINANCE
Answers to Concepts Review and Critical Thinking Questions
1. Capital budgeting (deciding whether to expand a manufacturing plant), capital structure (deciding
whether to issue new equity and use the proceeds to retire outstanding debt), and working capital
management (modifying the firm’s credit collection policy with its customers).
2. Disadvantages: unlimited liability, limited life, difficulty in transferring ownership, hard to raise
capital funds. Some advantages: simpler, less regulation, the owners are also the managers,
sometimes personal tax rates are better than corporate tax rates.
3. The primary disadvantage of the corporate form is the double taxation to shareholders of distributed
earnings and dividends. Some advantages include: limited liability, ease of transferability, ability to
raise capital, and unlimited life.
4. In response to Sarbanes-Oxley, small firms have elected to go dark because of the costs of
compliance. The costs to comply with Sarbox can be several million dollars, which can be a large
5. The treasurer’s office and the controller’s office are the two primary organizational groups that
report directly to the chief financial officer. The controller’s office handles cost and financial
6. To maximize the current market value (share price) of the equity of the firm (whether it’s publicly-
traded or not).
7. 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
equity of the firm.
8. A primary market transaction.
B-2 SOLUTIONS
9. In auction markets like the NYSE, brokers and agents meet at a physical location (the exchange) to
match buyers and sellers of assets. Dealer markets like NASDAQ consist of dealers operating at
10. 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
11. 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.
12. 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
13. 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.
14. 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
15. We would expect agency problems to be less severe in countries with a 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
CHAPTER 1 B-3
16. How much is too much? Who is worth more, Ray Irani 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
