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CHAPTER 2
THE FIRM AND ITS GOALS
QUESTIONS
1. Yes. The company can profit from this action in several ways. Graduate students, impressed with
2. This is an incomplete objective, and may not be consistent with the objective of profit
3. This comment is incorrect. It is quite true that the existence of consumer organizations, legal
requirements and warranty requirements may raise a company’s costs above what they would have
4. Shareholder wealth maximization is the more comprehensive of the two. Profit maximization is a
But a company with longer range horizons will want to consider a stream of earnings (or cash
flows) over time. This stream is then discounted at the company’s cost of capital to the present to
5. Stockholders generally may not know what maximum profits their firm could generate. Thus, they
6. The “principal-agent problem” refers to the possible divergence of objectives between the owners
The Firm and Its Goals 6
7. Since the ownership in a corporation is widely dispersed, and thus individual stockholders have
little power, it may be believed by managers that it is not necessary to endeavor to maximize
company profits. Since the managers usually own only a small fraction of the corporation’s stock,
8. There are several forces which will tend to create a convergence between the interests of
a. Corporate shares are not only owned by widely dispersed stockholders but by large institutional
holders (banks, insurance companies, mutual funds, pension funds). These organizations
b. Competitive pressures could lead to stock price declines for a non-performing company, and
c. In many corporations, management remuneration is tied to performance and managers
9. It probably does. Other types of objectives may be partial; but profit and wealth maximization still
10. No. Accounting depreciation is calculated on historical costs. Thus, depreciating a machine which
cost $10,000 when originally purchased can result only in a maximum of $10,000 of depreciation
11. Implicit costs can include in them costs not considered by accountants, such as the owners’
12. You would compare the amount of time spent on each employment, projected business profits
versus salaries that could be earned from working for others, the interest that you could earn on
Copyright © 2014 Pearson Education, Inc.
The Firm and Its Goals 7
13. Depreciation should reflect the actual change in the value of the equipment and the change in the
14. A multinational corporation is usually faced with different legal, economic, cultural and tax
15. Transaction costs are costs which a company incurs in dealing with other entities. Among the
costs incurred are those of investigation, contract negotiation, contract enforcement, and
16. As markets expand, companies specializing in particular products will grow and become efficient,
17. High transaction costs will cause a firm to internalize some of its costs. Some of the reasons for
high transaction costs are:
18. Using the constant dividend growth formula P = D1/(k - g), and noting that the $2 dividend was paid
last year, so this year’s dividend would be expected to be 6% higher:
19. Shareholder wealth is calculated by multiplying the number of shares outstanding by the price of the
stock. MVA is the difference between the market value of the company (including both stocks and
Copyright © 2014 Pearson Education, Inc.
The Firm and Its Goals 8
Copyright © 2014 Pearson Education, Inc.
