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2
Valuation: Measuring and Managing the Value of Companies, Sixth Edition
Chapter 3 Conservation of Value and the Role of Risk
Solutions
1. The conservation of value principle states that anything that does not increase cash flows does
not increase value. An example is an Internet company that lures viewers to a website but does
2. Changing capital structure creates value only if it improves cash flows or lowers the cost of
capital. The usual way cash flows improve is the increase in the tax shield from an increased
3. Financial engineering is the use of tools other than straight debt and equity to manage a
4. There is no value in simply becoming bigger through an acquisition. An acquisition will create
5. For publicly traded companies, nondiversifiable risk affects the cost of capital, and diversifiable
risk does not. Diversifiable risk arises from firm-specific factors, such as fluctuations in demand
6. The managers should hedge only risks that are not part of the core business. Investors invest in
7. Managers should not take on cash flow risk that has a measurable probability of bankrupting the
