CHAPTER 1
INTRODUCTION TO CORPORATE
FINANCE
Answers to Concepts Review and Critical Thinking Questions
1. Capital budgeting (deciding on 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).
4. 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 accounting, tax
management, and management information systems. The treasurer’s office is responsible for cash and
credit management, capital budgeting, and financial planning. Therefore, the study of corporate
finance is concentrated within the functions of the treasurer’s office.
5. To maximize the current market value (share price) of the equity of the firm (whether it’s publicly
traded or not).
8. In auction markets like the NYSE, brokers and agents meet at a physical location (the exchange) to
buy and sell their assets. Dealer markets like NASDAQ represent dealers operating in dispersed locales
who buy and sell assets themselves, usually communicating with other dealers electronically or
literally over the counter.
10. An argument can be made either way. At one extreme, we could argue that in a market economy, all
of these things are priced. This implies an optimal level of ethical and/or illegal behavior and the
framework of stock valuation explicitly includes these. At the other extreme, we could argue that these
are non-economic phenomena and are best handled through the political process. The following is a
classic (and highly relevant) thought question that illustrates this debate: “A firm has estimated that
the cost of improving the safety of one of its products is $30 million. However, the firm believes that
improving the safety of the product will only save $20 million in product liability claims. What should
the firm do?”
13. We would expect agency problems to be less severe in other countries, primarily due to the 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 addition, institutions may be able to implement more effective monitoring mechanisms
than can individual owners, given institutions’ deeper resources and experiences with their own
management. The increase in institutional ownership of stock in the United States and the growing
activism of these large shareholder groups may lead to a reduction in agency problems for U.S.
corporations and a more efficient market for corporate control.
15. The biggest reason that a company would “go dark” is because of the increased audit costs associated
with Sarbanes-Oxley compliance. A company should always do a cost-benefit analysis, and it may be
the case that the costs of complying with Sarbox outweigh the benefits. Of course, the company could
always be trying to hide financial issues of the company! This is also one of the costs of going dark:
Investors surely believe that some companies are going dark to avoid the increased scrutiny from
Sarbox. This taints other companies that go dark just to avoid compliance costs. This is similar to the