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Chapter 1 CFIN5
Chapter 1 Solutions
1-1 Finance deals with decisions about money. Finance decisions deal with how money is raised and used
1-2 Simply stated, everyone should have a basic understanding of finance because everyone faces
1-3 The value of a firm can be measured by the market value of its stock. Thus, the firm maximizes
1-4 Value is measured as the present value of the cash flows that an investment is expected to generate
during its life. The three factors that determine value are: (1) the amount of the future cash flows, (2)
1-5 Profit maximization abstracts from (1) the timing of profits and (2) the riskiness of different operating
plans. However, both of these factors are reflected in stock price maximization. Thus, profit
1-6 Such factors as a compensation system that is based on management performance (bonuses tied to
profits, stock option plans) as well as the possibility of being removed from office (voted out of office, an
1-7 The answer to this question depends on which action satisfies you more as the sole owner of the
business. But, chances are that you would be inclined to maximize your personal satisfaction, which
1-8 Provided that the rate of return on assets exceeds the interest rate on debt, greater use of debt will raise
the expected rate of return on stockholders' equity. Also, the interest on debt is tax deductible, which
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in
whole or in part.
Chapter 1 CFIN5
1-9 Corporate governance refers to the “set of rules” that a firm follows when conducting business. In
general, corporate governance relates to the manner in which a firm is operated. Corporate governance
affects the manner in which a firm approaches its decision-making tasks, treats its employees and
1-10 Firms “go international” for many reason, including to seek new markets, to get access to raw materials,
to avoid political hurdles, to name a few. Taking into account differential labor costs abroad,
1-11 Factors that make financial decision making more complicated for firms that operate in foreign countries
include differences in: currency, language, culture, governmental relations, political risk, legal structure,
1-12 The general areas of study in finance include: (1) financial markets and institutions, which includes the
study of the roles of banks, credit unions, and other financial organizations in the financial markets; (2)
Simply stated, finance deals with how firms generate and use funds. To do a good job, people must
understand how all four of the areas of finance are related. For example, publicly-traded firms raise
1-13 Proprietorship, partnership, and corporation are the three principal forms of business organization. The
advantages of the first two include the ease and low cost of formation. The advantages of the
The disadvantages of proprietorships and partnerships are (1) difficulty in obtaining large sums of
capital; (2) unlimited personal liability for business debts; (3) limited life; and (4) difficulty of transferring
1-14 Hybrid forms of business have been created over the years as the result of the needs of businesspeople
and investors. The hybrid forms of business generally include the advantages of partnerships and
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in
whole or in part.
Chapter 1 CFIN5
1-15 Ethics refers to the attitude and behavior that a firm applies when dealing with stakeholders. A firm must
consider all of its stakeholders—that is, investors, customers, employees, local community,
environment, and so forth—when conducting business; otherwise it will not stay in business for very
long. For example, if a firm makes huge profits at the expense of its customers, then the customers will
quit purchasing from the firm when they discover how they have been treated—the customers will either
1-16 A firm must consider all of its stakeholders—that is, investors, customers, employees, local community,
environment, and so forth—when conducting business; otherwise it will not stay in business for very
long. For example, if a firm makes huge profits at the expense of its customers, then the customers will
1-17 The corporate structure of foreign firms generally is characterized by greater concentration in
ownership, which often means more involvement in ownership and operations by large lenders, such as
banks and other financial institutions, and by large groups or families. In many instances, this means
that banks, other financial institutions, and ownership groups can meet most or all of the financing
needs of a firm. In the United States, on the other hand, banks and financial institutions are restricted in
the amounts of corporate debt and stock they can own. Thus, most large U.S. firms have very dispersed
ownership structures because they must raise needed funds from a large number of sources—it
generally is not possible to get the large amount of funds needed from a single source or even from very
few sources. “One-stop” financing outlets do not currently exist in the United States. It is argued that
It is difficult to say which form of business organization is better—the “open” company with disperse
ownership we have in the United States and Canada, or the more “closed” company with more
1-18 Stockholder wealth maximization is a long-run goal. Companies, and consequently the stockholders,
prosper when management makes decisions that will produce long-term increases in earnings. Actions
that are continually short-sighted often “catch up” with a firm and, as a result, it may find itself unable to
1-19 (a) Agency problems should not exist in a proprietorship, because there is only one owner, who
generally is the sole decision maker. The owner operates the business in a fashion that will
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in
whole or in part.
Chapter 1 CFIN5
(b) As more owners are included in a business, the likelihood of agency problems increases because
the potential for conflicts as to what actions promote the best interests of all owners increases. As
(c) As mentioned in part (b), the greater the number of owners in a business, the greater the
possibility of agency problems. Consequently, we would expect the potential for agency problems
1-20 The statement is not valid in every instance. Clearly, there are cases in which a firm’s stock price has
declined as the result of managerial decisions that were not in the best interest of shareholders.
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in
whole or in part.
